I-Bonds are all the rage – what’s the best way to use them?

With the release of the consumer price index in March, we now know that a risk-free asset with a yield of 9.6% will be available from May 2nd. I’m talking about Series I, of course savings bonds from the US Treasury Department that have been all the rage lately. To take advantage of this, all you have to do is open an account with TreasuryDirect.gov. Last year it took me a full 10 minutes to open my account.

me first wrote on I-Bonds in October 2021. Since November of last year, these bonds have returned just over 7.1%, which is pretty great for a risk-free investment. Unlike traditional bonds, which have been absolute beat up This year, Series I savings bonds are much safer – because they’re guaranteed to keep pace with inflation and there’s no interest rate risk, meaning they won’t lose value if interest rates rise.

There is a unique time slot this month. By buying I-Bonds in April this is possible lock in the current 7.1% interest rate for the next six months. You will then receive the new rate of 9.6% for the following six months. Because the interest earned on I-Bonds is compounded every six months, your total return over the next 12 months is 8.5%.

Read: The Silver Lining of Rising Inflation: I-Bond Yields Should Surpass 9%

Thanks to these delicious returns, investors have some intriguing arbitrage opportunities at their disposal. The strategies take advantage of the large interest rate differential between I-Bonds and other investments. The most obvious opportunity: Buy an I-Bond with cash you have in bank accounts and money market funds, assuming you don’t need to access that cash for at least a year. But here are five other strategies to consider:

1. Reap tax losses into your retirement funds.

Given the horrible beating Bonds have endured this year – and the worst may be yet to come – chances are you will suffer significant losses in many of your retirement funds. If these retirement funds are held in a taxable account, you can benefit from tax loss absorption. By selling up to $10,000 of these bond funds and using the proceeds to buy an I-Bond, you can use the capital loss to lower your 2022 tax bill while earning a guaranteed 8.5% return over the next 12 months – assuming you buy in April.

2. Pay out existing CDs and invest the proceeds in I-Bonds.

Selling certificates of deposit to buy an I-Bond makes a lot of sense, even if it means paying a penalty for paying out your CD early. For example, if you have $5,000 in a 12-month CD with an interest rate of 1%, you only earn $50 in interest. The same money put into an I-Bond today with a prospective yield of 8.5% would earn you $425 in interest, or $375 more. Even after paying any prepayment penalty on the CD, you are way ahead. Just remember that I-Bonds cannot be sold until a year after the date of purchase.

3. Buy I-Bonds instead of paying your mortgage up front.

If you have a mortgage, chances are very good that your interest rate is well under 8%. The last time interest Interest rates on 30-year fixed-rate mortgages were over 8% in 2000. This presents an arbitrage opportunity for homeowners. If you can buy I-Bonds at an 8% or 9% yield, there’s no reason to prepay your mortgage with additional principal payments — at least not until you hit the annual maximum in I-Bonds invested, which is $10,000 per person, $20,000 for a married couple and $30,000 for a married couple with a trust. The interest you earn on this I-Bond will far exceed the interest you save Advance payment your mortgage.

The same logic applies to a Equity capital Line of credit (HELOC). I’m generally opposed to using leverage, but it might make sense to borrow money from your HELOC and then invest the money in an I-Bond. According to Bankrate.com, many are HELOC Prices still below 4%. Should the interest rate on your HELOC rise above that of your I-Bond, simply sell the I-Bond and use the proceeds to pay off your home loan.

While this strategy requires some effort — including being mindful of interest rates — the payoff is significant. If your HELOC has an interest rate of 3% and you earn 8.5% on I-Bonds over the next 12 months, a $30,000 I-Bond investment would give you a $1,650 head start, and that’s just for one Year.

4. Do the math for student loans.

The average interest rate on student loans, both federal and private, is 5.8%. The average is 4.12% for federal student loans. The math that applies to mortgages and HELOCs also applies to student loans. Given I-Bonds’ juicy returns, it can be worth making the minimum payment on your student loans and investing the rest in I-Bonds. Again, this strategy could be reversed if interest rates on I-Bonds fall below those of your student loans.

5. Consider building an I-Bond ‘war chest’ for retirement.

As we enter a new era of higher inflation — say 4% to 5% per year — it might be worth starting an I-Bond war chest. Unless the buy limit is I-Bonds behaved, building a large I-Bond portfolio will take time. But such a portfolio can have many benefits, especially for retirees.

Inflation is one of the biggest risks facing retirees, and the longer you retire, the greater the risk. For example, a 5% annual inflation rate over 13 years would almost halve the purchasing power of the dollar. Equities offer some protection against inflation, but at the expense of yield risk. I-Bonds protect against both inflation and Series Risk. A sizeable I-bond portfolio could yield returns in the crucial years leading up to and after retirement, when subsequent risk is at its highest. Also, a sizeable I-Bond allocation could allow retirees to hold more stocks in the rest of their portfolios without losing too much sleep. In addition, an I-Bond could serve as a source of liquidity for spending shocks during retirement.

How do you build an I-Bond war chest? Suppose you are married and retire in 10 years. If you set up a trust, you could buy $30,000 worth of I-Bonds a year for the next 10 years. With some tax planning, you could increase that limit to $35,000 per year since your tax return can be used to purchase an additional $5,000 in paper I-Bonds each year.

That means you and your spouse could collectively buy up to $350,000 worth of I-Bonds over the course of 10 years, knowing those dollars will retain their inflation-adjusted value. Should you retire with stocks at all-time highs, you could keep your I-Bonds and sell stocks to generate income. But when stocks are down, you could start liquidating your I-Bonds to give your stock portfolio time to recover.

This article first appeared on Humble dollar and has been republished with permission.

John Lim is a physician and the author of How to Raise Your Child’s Financial IQ, which is both a free pdf and a Kindle edition. Follow John on Twitter @JohnTLim and check out his earlier article.

https://www.marketwatch.com/story/5-ways-to-use-i-bonds-11651156814?rss=1&siteid=rss I-Bonds are all the rage – what’s the best way to use them?

Brian Lowry

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