Are I Bonds A Good Investment Now?

Editor's Note: The bond rates and CD rates discussed in this article have changed since the article was first published. The current IBond rates are found here, and 5-year CD rates are here.

I Bonds have never made much sense to me. They generally offer yields that are below the top certificate of deposit rates and have low maximum investment limits. Today, I read an article in the Wall Street Journal recommending I Bonds as a safe investment alternative so I decided to take another look. Here's what I found.

Safety

I Bonds are issued by the US Treasury, presumably making them one of the safest investments in the world. They are backed by the Federal Government of the United States. Deposit account at your bank (savings accounts, Certificates of Deposit, money market account) are backed by the FDIC a government chartered and run entity. The FDIC taxes banks based on their risk profiles to fund its insurance. Right now, the FDIC has approximately $40 billion in deposits. Even if another big bank failure wipes out the $40 billion, analysts expect the government to step in and provide the FDIC with additional cash. From Bloomberg:

"It won't take many more failures before the FDIC itself runs out of money. The agency had $45.2 billion in its coffers as of June 30, far short of the $200 billion Whalen says it will need to pay claims by the end of next year. The U.S. Treasury will almost certainly come to the rescue by lending money to the FDIC.

Regardless of who wins control of the White House and Congress in November, no politician is likely to vote in favor of leaving federally insured depositors out in the cold."

Both seem pretty safe to me.

Rate

On rate, I Bonds are still not as attractive as a high yield CD. I Bond yields consist of two parts. A fixed yield, which is guaranteed for the 30 year life of the bond, and a floating rate which moves up or down depending on inflation. Right now, the fixed yield of an I Bond is 0%. So you're starting with a 0% yield. The variable rate the I Bond pays is 4.84%. That rate will go up next month to 4.92% based on the last six months of inflation data. Rising oil and commodity prices pushed up inflation, raising the yield on I Bonds. This variable yield is fixed for six months and readjusted twice a year, on May 1 and Nov. 1. That means if you opened a bond on Nov 1, you are guaranteed the 4.92% yield for six months. After that, it could be adjusted depending on what happens to inflation. For more on how this rate is calculated, visit the I Bond page.

My expectation is that with plummeting oil prices and a major recession, inflation is going to moderate, if not disappear. We are in a recessionary and deflationary environment now, not an inflationary one. As a result, you can expect I Bond yields will drop after May 1.

Now, compare that with getting a 5-year CD. The top 5-Year CD Rates on the BestCashCow rate table are above 5.2% APY. That's a rate guaranteed for five years and if you stay below the FDIC minimums the money is virtually backed by the United States government, making it as safe as an I Bond.

If you really want to get sophisticated, you can ladder a CD portfolio and create some of the inflation adjusted mechanisms of an I Bonds while retaining your flexibility and your higher FDIC insurance limits.

Or, you could park your money in a FDIC-insured money market or or savings account. The top savings rate according to the BestCashCow rate tables is 4% APY, very competitive with the I Bond yields. As another bonus, your funds are liquid. Yes, your rate will move up or down depending on the Fed Funds rate and the economy, but these changes will just mirror what's happening with the I Bond. I Bonds respond to inflation and so do money market and savings account rates.

Investment Limits

There still might be a benefit to I Bonds if you want to invest large amounts of money above FDIC insurance limits. The problem is that you can only invest $5,000 per social security number in each type of Treasury Bond. By buying $5,000 in I Bonds from your bank and $5,000 from Treasurydirect.com, you can increase that limit to $10,000 per calendar year, but that's still a far below FDIC insurance limits.

So, unless anyone can present any other reason to invest in I Bonds, I'll stick with FDIC insured deposit account.