Could an I bond protect your portfolio from inflation?

FeaturedMoney

Written by:

 

As inflation rates rise, consumers are struggling to find room in the budget for rising costs. But inflation has been good for the performance of Series I savings bonds, government-backed securities that are currently paying 9.62% interest per year.

“The major advantage of buying I bonds is that they currently have a high yield and are designed to help protect against inflation, which is something that many have worried about through the first half of 2022,” says Drew Feutz, certified financial planner and co-founder of Migration Wealth Management. The rate they’re paying “is much higher than what you will find on the rate of other high-quality bonds.”

I bonds offer low risk and pay out big when inflation soars. Here’s how they work and how you can buy them.

______________________

SPONSORED: Find a Qualified Financial Advisor

1. Finding a qualified financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to 3 fiduciary financial advisors in your area in 5 minutes.

2. Each advisor has been vetted by SmartAsset and is held to a fiduciary standard to act in your best interests. If you're ready to be matched with local advisors that can help you achieve your financial goals get started now.

______________________

 

 

 

Bond indices

How I bonds work

You might be more familiar with Series EE savings bonds, which earn a fixed interest rate for the bondholder for the lifetime of the savings bond. I bonds are similar in that they are fully backed by the U.S. government and mature in 30 years.

Unlike traditional savings bonds, a Series I savings bond earns a composite rate made up of two factors. The first is a fixed rate, set when you buy the bond, that remains the same forever. The second is a variable inflation rate that is readjusted every six months based on the Consumer Price Index for all Urban Consumers. Those rates are added together to arrive at the current rate on the bond.

Currently the fixed rate is set at 0%, but the annual inflation rate on the bonds is 9.62%. This means that bonds issued from May through October this year pay 9.62% for six months from the time of purchase, when they readjust based on the latest inflation rate.

I bonds earn interest monthly for thirty years or until you cash out the bond, whichever happens first. You can cash out the bond after twelve months, but you’ll lose the final three months of interest if you cash out before the bond is five years old. After five years, there is no penalty for cashing out early.

When inflation is high, the return on I bonds improves. Every six months, the interest your bond earned for the previous six months is added to the bond’s principal value, and the ensuing interest the bond earns is based on the new principal amount. I bonds are best used as long-term investments with reliable returns that keep up with inflation.

But I bonds aren’t a good fit if you need quick access to your funds, because you’ll lose out on earnings if you cash out in less than five years. And the 9.62% earnings rate isn’t guaranteed beyond six months. If inflation decreases, so will your earnings rate. When inflation drops, the return will drop too.

“I bonds should be considered a cash holding in your portfolio that you don’t need to access within 12 months. It’s important to note that I bonds do not pay out interest payments like many fixed income assets do,” Feutz says.

Earnings on I bonds are subject to federal income tax, but you can defer paying for up to 30 years, once the bond matures. Earnings may be tax exempt if you use them to pay for qualified higher education expenses. They are not subject to state or local tax.

“You can choose to report I bond interest and pay taxes every year or defer until you cash the bond or it matures,” Feutz says.

SPONSORED: Find a Qualified Financial Advisor

1. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to 3 fiduciary financial advisors in your area in 5 minutes.

2. Each advisor has been vetted by SmartAsset and is held to a fiduciary standard to act in your best interests. If you’re ready to be matched with local advisors that can help you achieve your financial goals, get started now.

How to buy I bonds

To buy I bonds, you must have a Social Security number and be a U.S. citizen, a U.S. resident, or a civilian employee of the U.S. government.

You can buy up to $10,000 in electronic I bonds in a single year by creating a TreasuryDirect account, which allows you to buy bonds and complete most transactions online for free. To open an account you will need a Tax ID number (social security number or employer identification number), U.S. address, email address, and a bank account and routing number. You can buy electronic I bonds in any amount, down to the penny, when you purchase $25 or more.

You can also purchase up to $5,000 in paper I bonds per calendar year using your federal income tax return. You have to submit IRS Form 8888 with your tax return, completing part two to instruct the IRS to use your refund to buy paper I bonds.

Paper bonds are available in denominations of $50, $100, $200, $500, and $1,000. The bonds will be issued and mailed to you when the IRS processes your tax return. Any remaining funds left from your tax refund will be sent to you by direct deposit or check.

“Be sure to only buy I bonds through Treasury Direct or your tax return, as anything else you might find may be a scam,” Feutz says.

Between electronic I bonds and paper I bonds, you can buy up to $15,000 in I bonds in a single year. Any bonds you receive as a gift count toward your annual limit, unless you receive them due to the death of the original owner or you convert a paper bond issued before 2008 to an electronic bond.

This article originally appeared on Policygenius.com and was syndicated by MediaFeed.org.

More from MediaFeed:

How to invest & profit during inflation

 

The inflation rate, or the rate at which prices are increasing, is going up in 2021, with the core U.S. inflation rate up to 5.4% in mid-2021. That’s a fairly big number, given the U.S. inflation rate stood at 1.4% only last January.

 

That has an impact on both consumers and investors. When inflation rises, consumer prices rise with it. Common goods like lumber, gasoline, semiconductors and grocery items like bacon and bananas have seen prices soar this year as a result of rising inflation, meaning that consumers’ paychecks might not go as far. If wages are rising at the same time as inflation, the impact on consumers is much less severe.

 

Rising inflation can also affect the stock market. Traditionally, rising inflation has tempered stock market growth, as consumers have less money to spend and the Federal Reserve may step in to check rising inflation by making loans and credit more expensive with higher interest rates.

 

What’s an investor to do when inflation is on the upswing? Often, it means adjusting investment portfolios to protect assets against rising prices and an uncertain economy.

 

Related: How can I invest $1,000?

 

fotopoly/istock

 

Inflation is largely defined as a continuing rise in prices. Some inflation is OK– historically, economic booms have come with an inflation rate at about 1.0%-to-2.0%, a range that reflects solid consumer sentiment amidst a growing economy. An inflation rate of 5% or more can be a different story, with higher rate levels associated with an overheated economy.

 

Inflation rates often correlate to economic growth, which is not always bad for consumers. When economic growth occurs, consumers and businesses have more money and tend to spend it. When cash is flowing through the economy, demand for goods and services grows and that leads food and services producers to raise prices. That triggers a rise in inflation, with the inflation rate growing even more as demand for goods and services outpaces supply.

 

Conversely, when demand slides and supply is in abundance, prices fall and the inflation rate tumbles as economic growth wanes. In 2021, however, the US economy is heating up after muted growth in 2020, and the inflation rate is on a significant upward trajectory.

 

In the United States, the main barometer of inflation is the Consumer Price Index (CPI). The CPI encompasses the retail price of goods and services in common sectors such as housing, healthcare, transportation, food and beverage, and education, among other economic sectors.

 

The Federal Reserve uses a similar index, the Personal Consumption Expenditures Price Index (PCE) in its inflation-related measurements. Economists and investors track inflation on both a monthly and an annual basis.

 

marchmeena29 / istockphoto

 

Historically there are two types of inflation: cost-push inflation and demand-pull inflation.

 

 

CasPhotography/istock

 

This type of inflation is an economic condition when goods and services are limited in supply, and where demand “pushes up” prices on those same goods and services. Take the cost of lumber in the first half of 2021, which was up substantially. Any increased price of lumber for building and construction leads to a lower lumber supply. With demand for lumber both sustained and intense, the price of lumber rises – or is “pushed” higher. Cost-push inflation also often occurs following a natural disaster (i.e., like when a hurricane closes oil refineries, leading to a lower supply of oil and gas, which leads to higher prices for both commodities.)

 

 

DepositPhotos.com

 

This type of inflation occurs when prices rise in the consumer economy. When jobs are plentiful and consumer sentiment is high, or the government has pumped a large fiscal stimulus into the economy. People tend to spend more money on goods and services. Yet if the goods consumers are limited (such as smartphones or used cars), competition for those goods rises, and so do the prices for those goods.

 

Demand-driven inflation is often referred to as “too many dollars chasing too few goods,” meaning the competition among consumers for specific goods and services drives prices significantly higher.

 

DepositPhotos.com

 

Inflation impacts both stock and bond markets but in different ways.

 

 

HAKINMHAN/istockphoto

 

Inflation has an indirect impact on stocks, primarily reflecting consumer purchasing power. When inflation rises, that puts pressure on stock market returns to keep up with the inflation rate. Consider a stock portfolio that earns 5% before inflation. Add the 5.4% inflation rate U.S. investors have seen (on average) over the past year, and the portfolio actually loses 0.4% on an inflation-adjusted basis. Plus, as prices rise, retail investors may have less money to put into the stock market, reducing market growth.

 

Conversely, some inflation stocks can perform well in periods of high inflation. When inflation hits the consumer economy, companies boost the prices of their goods and services to keep profits rolling, as their cost of doing business rises at the same time. Consequently, rising prices contribute to higher revenues, which helps boost the price of a company’s stock price. Investors, after all, want to be in business with companies that have strong revenues.

 

Overall, however, rising inflation raises the investment risk of an economic slowdown. That scenario doesn’t bode well for strong stock market performance, as uncertainty about the overall economy tends to curb market growth, thus reducing company earnings which leads to sliding equity prices.

 

DepositPhotos.com

 

Inflation can crimp bond market performance, as well. Most bonds like US Treasury, corporate, or municipal bonds offer a fixed rate of return, paid in the form of interest or coupon payments. As fixed-income securities offer stable, but fixed, investment returns, rising inflation can eat it those returns, further reducing the purchasing power of bond market investors

 

 

Depositphotos

 

Investors can take several action steps to protect and potentially outperform with their portfolios during periods of high inflation. You don’t have to worry about choosing the best investments during hyperinflation, because it’s highly unlikely that runaway inflation will occur in the United States.

 

Choosing inflation investments is like selecting investments at any other time – you’ll need to evaluate the security itself, and how it fits into your overall portfolio strategy both now and in the future.

 

nortonrsx

 

For instance, investors might consider stocks where the underlying company can boost prices in times of rising inflation. Consider a big box store with a global brand and a massive customer base. In that scenario, the retailer could raise prices and not only cover the cost of rising inflation, but also continue to earn profits in a high inflation period.

 

 

DepositPhotos.com

 

Think of a consumer goods manufacturer that already has a healthy portion of the toothpaste or shampoo market, and doesn’t need excess capital as it’s already well-invested in its own business. Companies with low capital needs tend to do better in inflationary periods, as they don’t have to invest more cash into the business just to keep up with competitors – they already have a solid market position and already have the means to produce and market their products.

 

 

DepositPhotos.com

 

Treasury Inflation-Protected Securities can be a good hedge against inflation. By design, TIPS are like most bonds that pay investors a fixed rate twice annually. They’re also protected against inflation as the principal amount of the securities is adjusted for inflation, based on Consumer Price Index levels.

 

 

webking / istockphoto

 

Precious metals, oil and gas and orange juice can all be good inflation hedges as well. Most commodities are tied to the rate of inflation and can capitalize in high inflationary periods. Take the price of gasoline, which rises as inflation heats up. Businesses and consumers are highly reliant on oil and gas, and will likely keep filling up the tank and heating their homes, even if they have to pay higher prices to do so. That makes oil – and other commodities – a good portfolio component when inflation is on the move.

 

 

DepositPhotos.com

 

By investing in short-term bonds and bonds funds, you’re not locked into today’s low rates for the long term. When interest rates rise, you can purchase new investments that reflect more favorable rates.

 

 

DepositPhotos.com

 

Investors should proceed with caution when inflation rises. While low inflation can indicate a healthy economy, high inflation can be a precursor to a recession. Massive changes to a well-planned portfolio may do more harm than good, and you shouldn’t toss out a long-term investment plan shouldn’t be deep-sixed just because inflation is moving upward.

 

Learn more:

This article originally appeared on SoFi.comand was syndicated by MediaFeed.org.

 

SoFi Invest
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA/SIPC. SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.


1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).


2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.


For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.

 

DepositPhotos.com

 

Featured Image Credit: CasPhotography/istock.

AlertMe