By David Enna, Tipswatch.com
Even before I Bond investors crashed the TreasuryDirect website in late October, many financial journalists were pondering this question: “How fast can you get out of I Bonds?” For example, this from MarketWatch in early October:
“You can hold on to Series I bonds for 30 years, but if you jumped in when the interest rate skyrocketed to 9.62%, you might be looking for an off-ramp well before then. If you were attracted primarily by the high yield, you may want to sell sometime in 2023.”
The reason, at least in theory, was that the I Bond’s inflation-adjusted variable rate was about to fall from the super-enticing 9.62% (for six months, annualized) to a lower rate, which ended up being 6.48%, not quite as “super,” but still enticing. Many new investors have bought into I Bonds as a short-term investment, which is totally logical. You can’t find returns like this on any other very safe investment.
A couple of things complicate an I Bond exit strategy: 1) You must hold the I Bond for 12 months before you redeem it, and 2) if you redeem before 5 years you will lose the last three months of interest. Because of that interest penalty, savvy investors will want to exit at a time when the last three months of interest are below current market rates. And that may mean waiting well beyond the required 12-month holding period.
The conventional approach. My advice on exiting I Bonds remains: “Redeem when you need the money.” I Bonds held for 5 years become an easily accessed pot of inflation-protected savings. So … my conventional thinking is: Buy I Bonds every year. After 5 years, consider selling when you need the money. And target the I Bonds with a 0.0% fixed rate for the first sales.
The short-term approach. OK … you need the money very soon, and you used I Bonds as a short-term savings investment. If you really need the money, just redeem after 12 months and take the 3-month interest penalty. You will still do OK. But the wiser approach, if you can afford it, is to hold off on redemptions until the 3-month penalty is applied to a lower interest rate and therefore less painful.
In this chart I have laid out the optimal exit month for all I Bonds purchased from October 2021 to November 2022. This is all subject to change, of course, because we don’t know what the I Bond’s next variable rate will be at the reset on May 1, based on October 2022 to March 2023 inflation.
The key to understanding this chart is that I Bonds earn the then-current composite rate for a full six months after the initial month of purchase. This is very important in planning your exit strategy.
For example, investors who bought I Bonds in October 2021 earned 3.54% for six months, then 7.12% for six months, then began collecting 9.62% just last month — in October 2022. They will launch into the 6.48% rate in April 2023. The next variable rate will begin in October 2023. Add three months to that and the optimal redemption date for I Bonds purchased in October 2021 is January 2024. (This assumes that the next variable rate reset will be below market rates. That may not be true.)
Investors who bought in November 2021 collected 7.12% for six months and then 9.62% for six months and this month began collecting 6.48% for six months. Add three months to that, and you get an optimal redemption month of August 2023.
Like a lot of people, I bought my full allocation of I Bonds in January 2022. My optimal month for redemption for those bonds doesn’t come until October 2023. That could be a factor if I wanted to sell those 0.0% fixed rate I Bonds and buy I Bonds with a higher fixed rate. (Mostly likely, I won’t be doing this.)
And so on through the chart. A lot of people bought I Bonds in October 2022, crashing the TreasuryDirect system. Those people will collect 9.62% for six months, then 6.48% for six months. Add 3 months and you get to an optimal redemption month of January 2024.
The holding period is potentially shortest for people who purchase I Bonds this month, in November 2022. They will collect 6.89% for six months (higher because the fixed rate rose to 0.40% for these purchases) and then an unknown rate for six months. If that rate is low enough, the optimal redemption rate could be November 2023, because the 3-month interest penalty could potentially fit into the first year.
Beware of assumptions! This chart lays out a potential optimal redemption dates for people looking to maximize earnings on a short-term I Bond investment. But if the next variable rate comes in very high — and it could — that would push out the holding period another six months for people who can afford to wait.
But my main point is: Don’t be too quick to hit the “exit” button on your I Bond investment. Take full advantage of the attractive rates you are now earning.
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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he discusses can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.