A reader whose financial savvy I highly value surprised me the other day by saying that he’d been maximizing his Series I Savings Bond purchases for many years. This surprised me since the “fixed” portion of the semi-annual composite interest rate had hovered between 0% and 0.5% APY since 2012, and the “inflation” portion of the composite rate between 0% (technically -0.8%, but when the composite rate falls below 0% they don’t actually reduce your principal) and 1.77%. The highest composite rate for newly issued Series I bonds in the last decade (until 2022’s November rate reset) was 4.05% APY, in November 2018 and May 2019, when inflation had started to creep up and interest rates were were rising towards the end of the long recovery from the events of 2007-2008.
4.05% APY in federal interest is competitive with the highest-earning rewards checking accounts once you account for state income taxes, but there were only two purchase periods when you could earn even that much, and only if you waited to meet the 2018 purchase limit until the November rate reset.
All this is true, but my surprise gave me an opportunity to reflect on how “stockpiling” Series I bonds might effectively play into an investment strategy.
In defense of smash-and-grab
My approach to these bonds is as a short-term, opportunistic play: in April and October each year you learn what the composite interest rate will be for purchases made in the next 6 months. Then you can decide whether to buy immediately (if the interest rate will fall), wait until the reset (if the interest rate will rise), or abstain (if the interest rate is too low to attract you). On the anniversary of each purchase, you have the same opportunity set: hold if the composite interest rate remains appealing, redeem if the composite interest rate has lost your interest (penalty free after 5 years, with a 3-month interest penalty if redeemed before that).
Let me stress that this is definitively not a recommendation to redeem your Series I bonds every year or every 5 years or every time the interest rate or inflation rate changes. On the contrary, it’s a set of choices.
For example, the very first issue of Series I bonds in 1998 had a fixed interest rate of 3.4% APY, which is in a 3-way tie for the second-highest fixed interest rate ever offered on these bonds (the highest was offered in May, 2000, at 3.6% APY). If you bought $10,000 in Series I bonds in May, 1999 (the earliest Treasury Direct will calculate for me), they’d be worth $36,052 today. That’s a compounded annual growth rate of “about” 6% depending on how you calculate it (since you earn interest for the entire month you bought your Series I bond regardless of how late in the month you buy it, precision quickly becomes difficult).
What I want this to illustrate is the importance of understanding the “composite” part of the composite interest rate: that first issue of Series I bonds are (or soon will be) earning 13.18% APY: their 3.4% APY fixed rate and the 9.62% APY May inflation adjustment. That means anyone who bought Series I bonds in 1998 and hasn’t redeemed them is making a positive killing on what is now (5 years having elapsed) an entirely cash-like asset. Yet the opportunity set is the same: if you have an investment opportunity offering more than 13.18% APY, you’re free to cash out and take that opportunity, but if you don’t, you’re also free to let your savings accumulate until the next inflation-component reset.
To put it even more simply, the fixed component of Series I bonds is more important in the long term, and the inflation component of Series I bonds is more important in the short term. That’s the smash-and-grab mindset.
In defense of stockpiling Series I bonds (if you’re playing it straight)
The wrench thrown in these gears is the annual purchase limit on Series I savings bonds: each Treasury Direct account has to be associated with a single taxpayer identification number, and the annual purchase limit is $10,000 through Treasury Direct (an additional $5,000 in “paper bonds” can be purchased with your federal tax refund).
This limit is hilariously trivial to evade. You can request additional EIN’s from the IRS for trusts, you can buy “gift” bonds that begin accruing interest immediately, or exploit any number of other workarounds.
But if you’re playing it straight, you have roughly $15,000-$25,000 in purchase limits per year. The significance of this is that even in years like 2015 when the fixed and inflation components of the composite interest rate were 0%, which occurred only once before, in 2009, it might be worth getting pieces on the board simply because you do not have the option of “catch-up” purchases in later years. Those May 2015 bonds, with their 0% fixed APY, are earning the same 9.62% composite APY as newly-issued bonds today.
Series I bonds are a tactic, but what you need is a strategy
One of my earliest obsessions when I started writing about personal finance and later became a financial advisor is how people fail to adhere to their own “risk tolerance.” Take someone with a $100,000 portfolio who has become firmly convinced that they belong in a portfolio of 60% equity and 40% fixed income, because that’s the amount of long-term volatility they can tolerate and the expected return they need to meet their investment goals.
Yet these people invariably have tens of thousands of dollars in cash in various accounts, “just in case” or “for emergencies.” Often this is the consequence of genuine trauma I don’t want to diminish or underplay: I had a check bounce once when I was between moves after college and spent weeks worrying whether the federal marshals were going to come arrest me!
Which brings me to my point: with $40,000 to allocate to fixed income, why would you put any of it in a bond fund paying 1% when cash accounts were paying 4.09%? This isn’t a rhetorical question; there are actual, practical answers. For example, tax-advantaged accounts have restrictions on what they can invest in, so folks with large retirement or 529 balances may have no other choice than to buy generic bond funds paying nominal interest. Likewise, high-interest checking accounts invariably have limits on the balances they’ll pay their highest rates on (typically between $10,000 and $25,000). Those are real limitations any sensible investor should take into account.
But from a holistic perspective, the investments in your tax-advantaged and taxable accounts, plus expected income from workplace pensions and Social Security’s old age benefit, should collectively reflect how you feel about both volatility and liquidity, the two most important inputs into what’s euphemistically called your “risk tolerance.”
Game finance, but holistically
To drill down on what I’m taking about, let’s use the example of an employee with a workplace-based 401(k) plan (with no employer match, to make it simple). They are convinced that due to their “risk tolerance” they should be invested in a broadly diversified 60/40 portfolio — good for them! They also decide to contribute the maximum employee-side contribution of $20,500 to their plan in 2022. Again — good for them!
Now consider that they open the newspaper, log into Twitter, or check in on Bogleheads and discover that they can buy $10,000 in Series I savings bonds earning 9.62% APY, and they jump on the opportunity. Our beloved worker is suddenly sitting on a 40/60 portfolio!
- $12,300 in 401(k) equities
- $8,200 in 401(k) fixed income
- $10,000 in Treasury Direct Series I bonds
This worker is invested in a portfolio that is much less risk tolerant than the one they set out to achieve and declared themselves capable of adhering to!
In one sense, the solution is obvious: the worker should reallocate their investments in their workplace retirement account to take on more equity exposure, since they now have this huge holding of high-interest cash-like reserves that can be used to meet any short-term needs. But how many people, when buying Series I bonds, really do increase their risk exposure in their retirement accounts? The number surely rounds down to zero.
I am obviously trying to thread a needle, but trying to do so as explicitly as possible: both opportunistic (smash-and-grab!) and stockpile models of buying Series I savings bonds are legitimate, legal, and defensible investment tactics. But if done indiscriminately and without reflection on other sources of income in retirement like Social Security there’s a very real risk of ending up with an overall retirement or investment portfolio that doesn’t look like you believe it should — and that’s true however you think your portfolio should look!