Take advantage of inflation: I-bonds yielding 7.12% have a role in your portfolio

Consumer Price Inflation surged 6.8% in November from year-ago levels, the biggest increase since June 1982.

Interest on Inflation-protected savings bonds (commonly called I-bonds) is linked directly to inflation. The interest rate paid on I-bonds is determined every six months and they are now earning an annualized 7.12%. This rate is available on bonds purchased now through April 30. Given much lower interest rates on other safe investments, they deserve a close look. The roles they can serve in your portfolio and details to be aware of are discussed below.

Roles for I-bonds

• A high yielding emergency fund, after a one-year holding period. I-bond yields are quite attractive to the alternatives. A comparably safe one-year CD earns about 0.65%. Savings accounts at major banks earn next to nothing. A one-year U.S. Treasury bill earns about 0.25%.
• An investment for buying stock funds after the stock market tanks. Periodic drops of 20% or more occur with regularity. I-bonds never decline in value serve as dry powder you can sell to fund those purchases.
• A safe asset that dampens the turbulence of stocks in your total portfolio.
• A secure source of funds to meet essential spending in retirement.
• A backup source of potentially tax-free funding for college expenses. 529 College Savings Plans are more effective for longer horizons because they have high stock allocations at early stages.

I-bond investment details

They:

• require a minimum purchase of $25.
• have annual purchase limits per social security number of $10,000 ($20,000 for a couple).
  • If liquidity allows, a couple could lock in the current 7.12% on $20,000 in 2021 and another $20,000 in 2022. 2022 purchases need to be made before the current May 1st inflation rate reset in 2022 to lock in the current 7.12%. Up to $5,000 more can be purchased by directing Federal tax refunds into I-bonds.
• do not decline in value. If deflation occurs, I-bond interest plus any fixed-rate interest rate does not fall below 0.0%. Deflation is rare but occurred in the 2008/09 financial crisis and when oil dropped sharply from 2014 to 2016 as seen in the chart above.
• are free from state and local taxes. Only Federal taxes apply.
• are tax-deferred for up to 30 years, full maturity. You can report interest every year but most wait until they redeem the bonds to take advantage of compounding.
• are purchased without transaction or fund/account management fees through the TreasuryDirect website.
• may earn a fixed rate on top of the variable inflation rate. The fixed-rate stays constant for as long as you own it but is now 0.0% and can be ignored.
• lose the last 3 months of interest if redeemed (sold) in less than 5 years. Even after a penalty, interest earned for a year will still be far ahead of CDs and other safe alternatives as shown below.

Potential I-bond interest after the 7.12%

I-bond interest rates reset twice a year on May 1^st and November 1^st. When the interest rate changes and what the rate will depend on when you buy them. The next May 1^st rate will be determined by unknown inflation from October 2021 to March 2022:

But October and November 2021 inflation are known: it was 7.14% and 6.50%. Inflation during the next four months is uncertain but is quite likely to remain elevated. This makes I-bonds a superb, but illiquid, investment choice for the next year.