The investment of the year in 2021, as far as I'm concerned, was the Series I Treasury bond, colloquially known as "I bonds". These bonds from the U.S Treasury, when purchased between Nov 2021 and Apr 2022, pay out a guaranteed 7.12% annualized interest rate for the first six months. That's a killer deal compared to other safe investments. For instance, the best "High Yield" savings accounts were paying out ~0.5%.
I Bond mechanics
I bonds are a type of bond issued by the U.S. Treasury which pays a variable interest rate based on inflation.
As you probably know, inflation in the U.S. in 2021 was higher than it has been in several decades, so the interest rate paid to I Bond holders was also high.
Here are the details:
- I bonds are issued by the U.S. Treasury and backed by the U.S. Government.
- You can only buy them on the Treasury Direct website, not through a broker. Creating an account may take 10 minutes or it may take weeks - sometimes they make you fill out a form, get it verified by your bank, then snail mail it back to them.
Rates
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The two factors that determine the interest rate for your I bonds are the fixed rate and the (adjustable) inflation rate.
The fixed rate is set at the time of purchase and does not change for the life of the bond.
The inflation rate is variable and changes every six months.
You can combine the two rates to get your actual rate (called the composite rate) using this formula:
composite rate = fixed rate + (2 * semiannual inflation rate) + (fixed rate * semiannual inflation rate)
Both rates are defined by the U.S. Treasury. The fixed rate has been nearly zero (or exactly zero) since 2008, which simplifies the equation:
composite rate = 2 * semiannual inflation rate
For example, for the period Nov 2021 through Apr 2022:
0 + (2 * 3.56%) + (0 * 3.56%) = 7.12%
Both rates are announced every six months by the U.S. Treasury. The Treasury Direct website lists all historic rates.
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New rates are announced semi-annually on the first business day in May and on the first business day in November.
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You get the current rate for 6 months after purchasing the bond, even if you buy it the day before the rate changes.
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You get all the interest for the month if you have the bond for even a single day in that month. So, it's best to buy the bond on the last day of the month and sell it on the first day of the month (this way you get nearly two free months of interest).
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Though the inflation rate may go negative in periods of deflation (and offset any fixed rate), the composite rate can never be less than zero, so they'll never decrease in value.
Holding Requirements
- You can not sell I bonds until you have held them for one year.
- You can sell I bonds between one and five years, but you forfeit 3 months of interest (this is closer to one month if you use the first and last day trick).
- You can sell them after 5 years at any time for full interest.
- I Bonds will stop accruing interest after 30 years.
Taxes
- Gains from I bonds are not subject to state taxes.
- Gains from I bonds are subject to federal tax, unless you use them for educational expenses AND you are a qualifying person (For 2021: MAGI < $98,200 for single/head of household/qualifying widow(er) or < $154,800 for married filing jointly).
- Tax deferred earnings - you do not have to pay taxes on your earned interest every year. You can wait to pay taxes until you sell your I Bonds.
Limitations
- You must have a SSN (or TIN) to purchase.
- Investors are limited to purchasing a maximum of $10k per year of I bonds per SSN (e.g., $10k for you, $10k for your spouse, $10k each of your children).
- Trusts can purchase $10k per year of I bonds.
- Individuals can get an additional $5k of I bonds per year by electing to receive tax refunds as an I bond.
I bonds may be a killer deal compared to savings accounts, but compared to the broader stock market investments over the long term, they aren't amazing. The S&P500 has historically averaged a 7% real return, and if your I bond fixed rate is zero (or nearly zero) you're looking at a ~0% real return... meh.
The real benefit that I bonds bring is safety. Unlike stocks, which are volatile, I bonds are backed by the full faith and credit of the U.S. government. You are guaranteed (as much as anything can be guaranteed) to get the promised rate.
So, if your money is primarily in a "high interest" savings account, I bonds this year are a slam dunk for more growth if you don't need the money within a year. If your money is primarily invested in the market, I bonds might still make sense as a sort of second-level emergency fund (after holding them for a year). This way you can keep your checking/savings account balances to a bare minimum.
Annual profit per $10k I bonds - selling after one year
Worst case
What's the worst that can happen? I bond returns can't go below zero, even in deflationary environments. So, the worst case, minimum profit scenario here is:
- 7.12% return for the first six months
- 0% return for the following six months
- Sell the bonds after one year
- Take advantage of the fact that you get all the I bond interest for the whole month if you hold it for even just one day during that month - which makes forfeiting 3 months of interest look more like your forfeiting 1 month of interest
The final bond value, after forfeiting the last 3 months, would be $10,349.88 (~$350 profit).
If your alternative investment is a savings account that pays 0.5% (~$50 a year an $10K), that's a free $300. Nice. It gets better though, because this scenario is incredibly unlikely given inflation's persistence...
Medium case
Alternatively, the average inflation rate paid on I bonds between Sept 1998 and Nov 2021 is 2.38%1. What if we got the 7.12% for the first six months, then the average inflation return (2.38%) for the next 6 months? We'll call this the medium case.
The final bond value, after forfeiting the last 3 months, would be $10,451.81, for a profit over a 0.5% savings account of ~$400.
Better case
What if the I bond inflation rate stayed the same at 7.12% (for both the first six months and the second six months)?
The final bond value, after forfeiting the last 3 months, would be $10,650.78, for a profit over a 0.5% savings account of ~$600.
This case (or better!) is looking like the most likely scenario based on recent inflation numbers and projections
Summary
It's likely that setting up a Treasury Direct account and adding $10k would take less than an hour (Finance Buff has detailed instructions here). For a profit of $300-600, that's a great hourly "wage".
Disclaimer
I, the author of this post, have no formal tax, accounting, or financial background. I've done my best to ensure the information is accurate, but it's possible that I've missed important information, miscalculated something, or made some other errors/omissions. If you see something that's incorrect, please contact me. As always, the site disclaimer applies.
Footnotes
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After zeroing out two periods of negative inflation (May 2015 and May 2009). ↩