Treasury Inflation-Protected Securities

Is the I Bond’s variable rate heading to zero? Maybe not.

Posted on January 13, 2023 by Tipswatch

Historical evidence clearly shows non-seasonal inflation lags from October to December, picks up from January to March.

By David Enna, Tipswatch.com

The one really big thing I have learned while writing about inflation and inflation protection over the last 12 years is this: You can’t assume anything about inflation. Years ago, I was perfectly willing to make predictions. Now, after getting spanked by inflation again and again, I just say: “Let’s wait and see.”

Take last year for example: When the June 2022 inflation report was released, the third in the six-month string for setting the I Bond’s variable rate, inflation was running at 3.03%. In just three months! That seemed to indicate — if this trend continued — the new variable rate could rise to 12% at the November reset. Several news reports touted 10% to 12% figures. I cringed.

The trend didn’t continue, and we hit three months of low inflation from July to September, resulting in a perfectly reasonable variable rate of 6.48%.

Now we are three months into a new six-month span that will reset the I Bond’s variable rate on May 1. The trend of seemingly low inflation is continuing and right now we are looking at a variable rate of 0.0%. Could that happen? Yes. Will it happen? Let’s wait and see.

Today, I decided to look at the last 10 years of October to March rate-setting periods for I Bonds, focusing on the ones where inflation started off slowly. And then ask: What was end result after the full six months? Let’s take a look.

2020

From October to December 2020, non-seasonally adjusted inflation ran at just 0.07%, indicating a “trend” toward a variable rate of 0.28%. But then inflation picked up from January to March 2021, and the resulting variable rate was quite a bit higher: 3.54%, annualized.

We saw a similar pattern in the April to September 2020 period, when inflation ran at -0.12% in the first three months, projecting a trend toward a variable rate of -0.48%. But then inflation popped higher, and the annualized variable rate ended up at 1.68%.

2019

From October to December 2019, inflation ran at 0.08%, projecting a trend toward an annualized variable rate of 0.32%. Inflation picked up (a bit) from January to March 2020, resulting in a variable rate of 1.06%.

2018

From October to December 2018, non-seasonally adjusted inflation ran at -0.48%, projecting a trend toward an annualized variable rate of -1.92%. At the time, I wrote this:

This is a fairly disastrous trend for holders of I Bonds, because even though an I Bond’s composite interest rate can’t go below zero, a negative variable rate will wipe out a matching amount of the I Bond’s fixed rate. … Still, this negative trend could reverse, at least partially, in the next three inflation reports.

And yes, the trend did reverse, with the annualized variable rate ending up at 1.4%.

2017

From October to December 2017, inflation ran at -0.12%, projecting the potential for a new variable rate of -0.48%. But then inflation rebounded in January to March 2018, resulting in a variable rate of 2.22%.

2016

Inflation from October to December 2016 ran at 0.0%, just like we are seeing in the last three months of 2022, projecting the potential for a 0.0% variable rate. But inflation rebounded from January to March 2017, resulting in an annualized variable rate of 1.96%.

2015

Non-seasonally adjusted inflation from October to December 2015 ran at -0.60%, projecting a possible trend toward a variable rate of -2.4%. Pretty disastrous, right? But it didn’t happen. Inflation rose enough in January to March 2016 to bring the variable rate up to 0.16%.

2014

Inflation from October to December 2014 ran at -1.35%, projecting a possible trend toward a variable rate of -5.4%. Deflation was bad, but not that bad. Inflation from February and March 2015 rebounded enough to get the variable rate to -1.60%, still a very ugly number.

Since I Bonds were first launched in 1998, there have been only two rate-setting periods resulting in a negative variable rate: This one in 2014, and the October 2008 to March 2009 period, which got a spectacularly low rate of -5.56%.

One oddity of I Bonds is that if you are going to have a negative variable rate, it’s better for it to be deeply negative. That’s because the composite interest rate can’t go below 0.0%, so you won’t lose a cent of principal, and you will be out-performing inflation for those six months. When inflation rebounds higher, you get the full benefit without suffering any penalty for deflation.

Historical perspective: A lesson learned

I could have continued this listing. In 2013, the October to December period ran at -0.47%, but the resulting annualized variable rate was 1.84%. In 2012, the October to December period ran at -0.78%, but the resulting variable rate was 1.18%. That is far back as my compiled data go.

Even if you look at 2021, when inflation was surging, the October to December period ran at 1.63%, projecting a trend toward a possible variable rate of 6.52%. But inflation surged even higher in January to March 2022, resulting in the epic variable rate of 9.62%.

Clearly, since this trend has continued for 10 straight years, non-seasonally adjusted inflation tends to under-report in the October to December period, and then rebound in the January to March period. This was easily seen in the November inflation report, with seasonally-adjusted inflation coming in at 0.1%, but non-seasonal at -0.1%. And then for December, seasonally-adjusted was -0.1%, while non-seasonal was -0.31%. Seasonal and non-seasonal balance out over 12 months, so we should see some gains in non-seasonal inflation in the months ahead.

So back to the question: Will the I Bond’s variable rate go to zero at the May 1 reset? Based on this historical evidence, I don’t think it will. It will be higher that 0.0%. But anything can happen. Let’s wait and see.

• I Bonds: A not-so-simple buying guide for 2023

• Confused by I Bonds? Read my Q&A on I Bonds

• Let’s ‘try’ to clarify how an I Bond’s interest is calculated

• Inflation and I Bonds: Track the variable rate changes

• I Bond Manifesto: How this investment can work as an emergency fund

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Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear.Please stay on topic and avoid political tirades.

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.

Posted in I Bond, Inflation, Savings Bond | 34 Comments

U.S. inflation fell 0.1% in December; a sign of things to come?

Posted on January 12, 2023 by Tipswatch

Data for three months indicate the I Bond’s variable rate could fall to 0.0%. What does it mean for investors?

By David Enna, Tipswatch.com

U.S. inflation transitioned to deflation in December, with the all-items Consumer Price Index for All Urban Consumers falling 0.1% for the month, after increasing just 0.1% in November, the Bureau of Labor Statistics reported today. Inflation for the year 2022 ended at 6.5%, falling below 2021’s 7.0%.

All-items inflation was below the consensus estimates of 0.0% for the month and 6.6% for the year, but more recent projections cited -0.1% for the month. Core inflation, which removes food and energy, ran at 0.3% for the month and 5.7% for the year, matching expectations.

So these numbers aren’t really much of a surprise. Expectations of easing inflation had sent the U.S. stock market surging higher — and Treasury yields falling — over the last two weeks. The S&P futures were up just slightly at 9 a.m., indicating a lack of euphoria (at least so far).

The BLS noted that gasoline prices, which fell 1.5% in the month, were the largest factor in the all-items index moving negative. Gasoline prices are now up just 0.4% year over year. More items from the report:

Food at home prices were up 0.2% for the month and 11.8% for the year. The index for meats, poultry, fish, and eggs increased 1.0% in December, but costs of fruits and vegetables fell 0.6%.
Shelter costs rose 0.8% for the month and were up 7.5% for the year. Shelter tends to be a lagging index, with leases rolling over gradually. Rents were up 0.8% for the month.
Apparel costs rose 0.5% for the month but were up just 2.9% for the year.
Costs for used cars and trucks fell 2.5% for in December, the sixth consecutive month of declines. New vehicle prices also fell by 0.1%.
The index for medical care services rose 0.1% for the month, after declining the two previous months.

This report presents positive news on U.S. inflation, but a lot of the December decline was due to falling gasoline prices. Food prices also moderated. Both of those factors are welcome for U.S. consumers. Shelter costs continued moving higher, but that was expected with higher rent costs rolling into effect. Clearly, U.S. housing prices are at least at a standstill with mortgage rates nearly doubling over the last year.

This disinflationary trend could continue for several months, because last year’s CPI numbers were quite high from January to June, making month-to-month baseline numbers hard to exceed. Even if monthly numbers rise, annual inflation should be declining in the first half of 2023. After June, inflation could pick up again, but that’s a long way off:

Here is the one-year trend for both all-items and core inflation over the last year, showing the dramatic fall in all-items inflation since June, and more recently the gradual fall in core inflation:

What this means for TIPS and I Bonds

Investors in Treasury Inflation-Protected Securities and U.S. Series I Savings Bonds are also interested in non-seasonally adjusted inflation, which is used to adjust principal balances on TIPS and set future interest rates for I Bonds. For December, the BLS set the CPI-U index at 296.797, a decline of 0.31% from the November number. Over the last year, non-seasonally adjusted inflation has increased 6.45%.

For TIPS. The December inflation report means that principal balances for all TIPS will fall 0.31% in February, following a decline of 0.10% in January. But over the last year, ending in February, principal balances will be up 6.45%.

Take for example CUSIP 912828WU0, a TIPS that matures July 15, 2024. Its inflation index will start the month of February at 1.25381 and end the month at 1.25009. This isn’t great news, but it is how TIPS work, tracking official U.S. inflation. Here are the new February Inflation Indexes for all TIPS.

For I Bonds. The December report is the third in a six-month series that will set the I Bond’s new inflation-adjusted variable rate. The reset will be on May 1 for I Bonds purchased from May to October 2023, but eventually will roll into effect for all I Bonds. Through December, inflation has run at 0.00%, meaning the I Bond’s new variable rate would be 0.00%, down dramatically from the current 6.48%. Here are the numbers:

Three months remain, and a lot can happen in three months. But as I noted earlier, the very high baseline numbers from 2022 indicate that disinflation, or deflation, could continue through June. But those baseline numbers really only effect the annual rate; the month-to-month inflation rate could move higher from January to March, but we are still likely to see a lower variable rate at the May reset.

For regular I Bond investors, this points to purchasing your 2023 I Bond allocation — $10,000 per person per calendar year — before May 1 to lock in the current 6.89% for six months, which includes the fixed rate of 0.4%. For short-term I Bond investors who bought in 2022, the next variable rate could give you an exit window with a very low three-month interest penalty.

See my recent post: I Bonds: A not-so-simple buying guide for 2023

And also: Short-term I Bond investors: Be patient with your exit strategy

If this disinflationary trend continues for several months, investor interest in I Bonds and TIPS is likely to wane. In fact, short-term investors should probably look at attractive nominal investments like a 1-year Treasury bill at 4.73%. But clearly we can’t be certain that the inflationary monster has been tamed in the long run.

What this means for future interest rates

The Federal Reserve seems highly committed to raising short-term interest rates by 25 basis points in early February, pushing the federal funds rate to 4.50% to 4.75%. Could that be the last rate increase? More likely, the second-to-last rate increase?

This morning’s Bloomberg report has this headline: “US Inflation Cools Again, Putting Fed on Track to Downshift“. Plus, rather comically, “Stocks Drop as In-Line CPI Fails to Sustain Rally“.

I have been theorizing that the Federal Reserve has been issuing hawkish public statements over the last month to try to cool market fervor over a stall — and then potential cuts — in interest rates. The bond market, though, hasn’t been listening, with mid- and long-term nominal and real yields falling in recent weeks.

I think we are nearing the end of this rate-hiking cycle. But the Fed has to continue to slash its massive holdings of U.S. Treasurys, and that roll-off or even sell-off should elevate bond yields, eventually. The unknown factor is the health of the U.S. economy and job market. If a recession hits with a vengeance, the Fed will back off, quickly and somewhat aggressively.

• I Bonds: A not-so-simple buying guide for 2023

• Confused by I Bonds? Read my Q&A on I Bonds

• Let’s ‘try’ to clarify how an I Bond’s interest is calculated

• Inflation and I Bonds: Track the variable rate changes

• Confused by TIPS? Read my Q&A on TIPS

• TIPS in depth: Understand the language

• Upcoming schedule of TIPS auctions

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Posted in Federal Reserve, I Bond, Inflation, Investing in TIPS | 20 Comments

Barron’s Live: Best Timing for I Bonds

Posted on January 9, 2023 by Tipswatch

Tipswatch.com

I participated Monday in a Barron’s Live 30-minute video podcast, hosted by Marketwatch columnist Beth Pinsker. The topic was strategies for buying Series I Savings Bonds in 2023. In January? In April? In May? Or just go with TIPS?

You can watch the video here (requires registration on the Barron’s site).

Or listen to the audio podcast on these links:

About this podcast

I Bonds, a once-obscure Treasury investment, soared in popularity last year because of its enticing inflation-adjusted rate that changes every six months, but individuals are limited by a $10,000 cap on purchases per year. Now that we’re in a new year, there are three key strategies to make the most of your investment. Join Beth Pinsker, investing columnist for MarketWatch and long-time journalist David Enna.

• I Bonds: A not-so-simple buying guide for 2023

• Confused by I Bonds? Read my Q&A on I Bonds

• Let’s ‘try’ to clarify how an I Bond’s interest is calculated

• Inflation and I Bonds: Track the variable rate changes

• I Bond Manifesto: How this investment can work as an emergency fund

Posted in I Bond, Investing in TIPS, TreasuryDirect | 14 Comments

TIPS funds vs. TIPS ladder: An investor weighs in

Posted on January 8, 2023 by Tipswatch

By David Enna, Tipswatch.com

A lot of readers ask about the ladder of TIPS investments I have built over the years. Yes, I do have a ladder, and it does hit every year from 2023 to 2032, and then jumps forward to 2041 and 2042.

Notice the gap? That’s because there are no TIPS issues that mature from 2033 to 2039. Why? Because the Treasury no longer issues 20-year TIPS, leaving a gap in maturities. So I will need to pick up those missing years, one at a time, beginning with this month’s auction of a 10-year TIPS, maturing in 2033.

While it might sound like my ladder was well planned, honestly it was built haphazardly, from purchases of 5- and 10-year TIPS, mostly at auction, and only when I judged real yields to be “attractive.” So the ladder has a lot of maturities this year, in 2023, and then in 2027, because of my purchases of 5-year TIPS in 2018 and 2022, the only two years in the last decade when real yields moved well above zero.

Here is what my ladder looks like, with a few nominals thrown in and actual investment amounts removed. I use an Excel spreadsheet to update the inflation indexes (drawn from the Wall Street Journal) and adjust my principal amounts a few times a year:

Two examples show the formula: Par x inflation index = adjusted principal. The original real yield is not shown in this chart, but I make a notation off to the right.

Now here we are in 2023, and again real yields are well above zero across the entire TIPS yield spectrum, with the 5-year at 1.68% and the 30-year at 1.55%. If you are interested in building a TIPS ladder, this is a great time to begin.

Why is a TIPS ladder attractive?

I recently read a well-thought out article titled, “TIPS Funds Vs. A Ladder,” on the SeekingAlpha site. The author is Ralph Wakerly, an investor, entrepreneur and consultant with over 35 years of investment experience. Wakerly argues that historical inflation data suggest the next decade of inflation “may run considerably above the ~3% that consumers and investors expect,” making TIPS a highly attractive investment.

I suggest that you read his entire article, but here are some of his major points:

“For investors at or near retirement, a TIPS ladder is an effective means of generating reliable, predictable income. …TIPS are most effective and reliable if held to maturity. This argues in favor of buying individual bonds via a ladder, not a mutual fund or ETF. …

“You can build an effective TIPS ladder that is relatively simple, with a manageable number of holdings via a mix of auction buys and via the secondary market. …

“A bond ladder via a brokerage account like Fidelity or Vanguard costs nothing. There are no transaction costs and no annual expenses.”

TIPS funds versus a ladder

You can find many smart investors (Bogleheads, especially) who argue that a TIPS fund or ETF is no more risky that holding individual TIPS to maturity. While there may be some logic to this argument (duration matching often comes up as a reason) you have to recognize that the biggest TIPS fund, the TIP ETF, had a total return of -12.24% last year, even as inflation soared to a 40-year high. If you own individual TIPS and are holding to maturity, you can ignore these market swings and just rake in the inflation accruals. At maturity, you are going to get par value x inflation accrual.

Wakerly came up with this comparison of TIPS funds vs. individual TIPS, an excellent summation:

Consider interest rate risk

As Wakerly notes. “This was painfully evident this year. Fund investors have been punished as the 10 year real TIPS rate went from -1% to the current 1.6%. … However, individual TIPS bonds held to maturity protect against principal loss in the event of rising real rates.”

At a time of rising real yields, TIPS funds are going to suffer. But an individual TIPS will stay on its course to maturity, where it will pay par value + inflation accrual (or at the very least, par value). If you hold a TIPS in a brokerage account, it can be painful to see the loss in “market value” because that is how the broker will report it each day. But in reality, your TIPS is actually holding its principal value (unless deflation strikes), and rising with future inflation. Wakerly says:

In my opinion, this is the most important advantage of buying individual bonds in a ladder versus a fund. This is especially important for retirement investors who want predictable income and cash flow.

Is a ladder really diversified?

Of course it is, if you do a decent job of spacing out maturities and the amounts invested. The TIP ETF only has about 48 holdings — that is all the TIPS trading on secondary markets. A ladder with a few holdings with attractive real yields, maturing at a date to match your needs, is well diversified. Wakerly notes:

From a bond diversification standpoint there isn’t a need to buy a fund. Unlike corporate or muni bonds where you want to diversify default risk across issuers, TIPS are effectively riskless assets backed by the full faith and credit of the US government.

On the other hand, keep in mind that TIPS are a highly specialized investment, designed to protect assets against future inflation. Most people would want to pair their TIPS holdings with low-cost stock index funds, traditional bond funds and some nominal fixed income, such as bank CDs or Treasurys.

Building a ladder

Wakerly says he is building a ladder with an eye on future income needs, so he is focusing on TIPS with a weighted maturity of 18 years. You’d need to consider your future needs. In my case, I am already retired and just trying to protect capital against future inflation, so my ladder focuses more on the near term. Here is Wakerly’s sample ladder:

Another strategy: I have heard from many readers who say they have built a TIPS ladder in their traditional IRA account to account for future required minimum distributions long into the future.

Conclusion

I highly recommend reading Wakerly’s complete article, which goes into greater detail, and another he recently wrote on TIPS titled, “TIPS Performance Could Rival That Of The S&P 500 Over The Next Decade“. (I’m not endorsing that opinion, but after the highly volatile 2022, anything could happen.)

But I do agree with his closing opinion:

“A TIPS ladder is an effective way to invest, especially for those in or near retirement who are comfortable creating their own do-it-yourself annuity. The ladder is currently generating one of the highest yields in the past 14 years with higher certainty of returns, and better principal protection than a mutual fund or ETF.”

One more thing …

For another interesting read on TIPS ladders, check out financial adviser Allan Roth’s October article, “The 4% Rule Just Became a Whole Lot Easier” in which he describes how he painstakingly built a TIPS ladder that will allow 4.36% inflation-adjusted withdrawals over 30 years. He notes, “This is a very attractive strategy for someone wanting a guaranteed inflation-adjusted cash flow in addition to Social Security.”

Roth built this ladder with the help of a Bogleheads contributor, Bob Hinkley, and his article set off a lively — and helpful — discussion in the Bogleheads forum. The article was also referenced in a December Morningstar article titled, “How to Build a TIPS Ladder“.

• Confused by TIPS? Read my Q&A on TIPS

• TIPS in depth: Understand the language

• Upcoming schedule of TIPS auctions

* * *

Posted in Inflation, Investing in TIPS, Retirement | 33 Comments

I Bonds: A not-so-simple buying guide for 2023

Posted on January 3, 2023 by Tipswatch

By David Enna, Tipswatch.com

Note: I posted an updated I Bond analysis on April 14:

Update, April 28, 2023: Treasury raises I Bond’s fixed rate to 0.9%; new composite rate is 4.30%

After a year of raging-high demand, where do we stand today on U.S. Series I Savings Bonds? Are they still an appealing asset? Are they a worthy investment for 2023? Is the variable rate likely to fall at the May reset? Should you hold out for a higher fixed rate later in 2023?

I Bonds are issued and guaranteed by the U.S. Treasury.

Last year, in January 2022, I titled my year-ahead guide “I Bonds: A very simple buying guide for 2022.” At the time, I Bonds had an annualized rate of 7.12%. By comparison, a 1-year Treasury bill was yielding 0.40%. See? My advice was simple: Buy I Bonds, in January or April or anytime between. But buy I Bonds.

This year, things are more complicated. Yields on nominal Treasurys are much higher. Real yields for Treasury Inflation-Protected Securities have soared to levels we haven’t seen in 15 years. Even bank CDs and online savings accounts are getting attractive. I Bonds have competition.

Before we get into those issues, here’s a quick primer for investors who are new to I Bonds:

The basics

The fixed rate of an I Bond will never change. Purchases through April 30, 2023, will have a fixed rate of 0.4%, which means their return will exceed official U.S. inflation by 0.4% until the I Bond is redeemed or matures in 30 years.
The inflation-adjusted rate (often called the I Bond’s variable rate) changes each six months to reflect the running rate of inflation. That rate is currently set at 6.48%, annualized, for six months. It will adjust again on May 1, 2023, rolling into effect for all I Bonds, no matter when they were purchased.
The current composite rate is 6.89% annualized for six months for purchases from January to April 2023.

I Bonds are an extremely safe and conservative investment. Interest accrues monthly and can never decline, even in times of deflation. Investments are limited to $10,000 per person per calendar year for electronic I Bonds held at TreasuryDirect. There is also the option to get $5,000 a year in paper I Bonds in lieu of a federal tax refund. There is also a “gift box” strategy some investors use to stack purchases for future years.

I Bonds are a unique investment with many positives. For example, earnings are free of state income taxes and federal taxes can be deferred until the I Bond is redeemed or matures. Also, I Bonds are a simple investment to buy and track, much simpler than a TIPS with a constantly changing market value and inflation accruals that update daily.

The purchase limit is the reason people ponder timing their I Bond purchases; once you hit $10,000 per person per year, you can’t purchase more, at least in the traditional way.

Are I Bonds still attractive?

I Bonds purchased from January to April 2023 will pay an annualized composite rate of 6.89% for six months, which includes the fixed rate of 0.4%. Is 6.89% attractive? Definitely. But let’s look at the alternatives:

A six-month Treasury bill has a nominal yield of about 4.76%.
Best-in-nation 6-month bank CDs are yielding about 4.4%.
A 1-year Treasury bill has a nominal yield of about 4.73%.
Best-in-nation 1-year bank CDs are yielding about 4.75%.
A 5-year Treasury note now yields about 4%.
A 5-year TIPS has a real yield of about 1.58%.

As a six-month investment, an I Bond definitely looks attractive. But keep in mind that an I Bond has to be held for at least 12 months, and redeeming before 5 years forfeits your last three months of interest. That brings uncertainty into the equation.

Short-term investment

If you are aiming to redeem the I Bond after one year, this still looks like a contender, but with complications. You are guaranteed to earn an actual return of 3.445% in the first six months (6.89%/2), and then some undetermined return in the next six months, depending on inflation from October 2022 to March 2023, plus the fixed rate of 0.4%.

And there is the problem: We can’t accurately project U.S. inflation for the October to March period. The first two months, October and November, are already in, and inflation ran at 0.30% over that period, averaging just 0.15% a month.

So I’d guess the variable rate at the May reset will be lower than the current 6.48%, but most likely will still be at least 1.8%, based on 0.15% monthly inflation on average over the six months. That’s a conservative estimate.

Add on the fixed rate of 0.4% and you can conservatively estimate an annualized return of about 2.2% in the second six months. That creates a total return of about 4.54% for one year (6.89% + 2.2% / 2 = 4.54%) Remember, this is a conservative estimate. If inflation runs higher, your return would be higher. If inflation runs at 0.4% from December to March, the new variable rate would be 3.8%. Add on the fixed rate and you get to 4.2%. Your total return after one year would be about 5.5%.

But … redeeming an I Bond after 12 months will incur a three-month interest penalty, wiping out more than 1% of that return.

Does all this mean that I think U.S. inflation has been tamed? Definitely not. But we are heading into a several-month period where the year-ago numbers will be very hard to match and exceed. So inflation should appear to “moderate” during that period. Take a look at the numbers: December 2021 at 0.31% is reasonable, but then you get January 2022 at 0.84%, February at 0.91% and March at 1.34%.

Conclusion. If your only interest in I Bonds is a quick one-year investment, you might want to look at competitive nominal investments like one-year bank CDs, online savings accounts or one-year Treasury bills. If inflation moderates, the returns could be similar but without the three-month interest penalty. The advantage of an I Bond is long-term inflation protection. If you aren’t concerned about inflation in the long term, look elsewhere.

But if you remain interested in the I Bond for one year, then I’d suggest using TreasuryDirect to set a purchase date later this month, maybe Jan. 27, to lock in January as your starting month. You could then redeem early in January 2024.

Long-term investment

Long-time fans of I Bonds buy them every year, up to the annual $10,000 per person purchase limit, to build a large cache of inflation-protected savings. After 5 years, an I Bond effectively becomes an inflation-protected, tax-deferred cash account you can draw from without penalty. (See the I Bond Manifesto for more on this.)

I am a long-time, devoted I Bond fan, and I will be buying I Bonds up to the limit this year. I want that higher fixed rate. But when to buy? The key factors in this decision are 1) potential changes in the I Bond’s variable rate, and 2) potential changes in the I Bond’s fixed rate.

Buying anytime from January through April will result in exactly the same return on your investment. That is because when you purchase an I Bond, you lock in the current composite rate (6.89%) for a full six months before the next rate reset. So a long-term investor has no urgent need to buy in January. In 2022, I bought in January to go ahead and grab the 7.12% variable rate. This year … I will wait.

Key date: April, 12, 2023. At 8:30 a.m. ET on April 12, the Bureau of Labor Statistics will release the March inflation report, setting in stone the I Bond’s next variable rate reset, going into effect May 1. At that point, you will also have an idea of where the I Bond’s fixed rate could be heading. And you will have about 15 days to decide: Buy in April, or in May?

As I said earlier, I think the variable rate could be heading lower, somewhere in the range of 1.8% to 4.0%. That’s a guess, not a projection. If the variable rate is going to fall, buying in April makes more sense, to capture 6.89% for six months.

But then there is the issue of the fixed rate. Long-term investors in I Bonds know that a higher fixed rate is always more desirable, because it stays with the I Bond for the entire 30-year potential term. Could the fixed rate rise on May 1? My guess is yes, it is possible if real yields continue holding at current levels, with the 10-year TIPS trading with a real yield of 1.58%.

(Update on January 9: The 10-year real yield has fallen to about 1.3% in trading today, dropping about 28 basis points in a week. Not a good indicator for a higher fixed rate for the I Bond, but a lot of time remains.)

Oddly enough, 1.58% is exactly where the 10-year TIPS was trading on Oct. 31, 2022, the day before the Treasury raised the I Bond’s fixed rate from 0.0% to 0.4%. My opinion: The fixed rate should have been higher, but I was pleased with the decision to raise it at a time when TreasuryDirect was overwhelmed by demand for I Bonds.

The Treasury has no public formula for setting the I Bond’s fixed rate, but I have contended for years that the 10-year real yield is the best indicator of where the fixed rate is heading. At the November reset, the yield spread was 1.18%, the highest since November 2008. The fixed rate could have been higher.

What about waiting until the Nov. 1 rate reset? I’d say no because you could risk losing the above-zero fixed rate if the Fed changes course, plus the attractive composite rate (6.89%) for six months. Anything can happen though. On Jan. 1, 2022, a higher fixed rate did not look all likely at the November reset — the 10-year real yield was -0.97%. Ten months later it had increased 255 basis points.

Conclusion. A higher fixed rate is a possibility on May 1, even as the variable rate might be going lower. For a long-term I Bond investor, I think it makes sense to wait until April 12 to make a purchase decision. And even then the decision might be to divide your purchases, half in April and half in May, if a higher fixed rate looks at all possible.

Redeem I Bonds to purchase I Bonds?

If you are a long-time investor in I Bonds, you probably have some issues with a 0.0% fixed rate and have hit the 5-year mark so they can be redeemed without penalty. For example, I have I Bonds issued in April 2017 that qualify. If I wanted to step up to the higher fixed rate, I could sell the April 2017 I Bonds and buy the April 2023 I Bonds, getting the 0.4% fixed rate.

The negative to this strategy is that I would owe taxes on the $1,704 interest I’ve earned. That would be costly. However, the strategy still makes sense for an investor that doesn’t want to raise additional money this year to buy the 2023 allocation.

Another alternative would be to redeem I Bonds with a fixed rate of 0.0% that you’ve held just a year or two. That would cost you three months of interest, but if you delay redeeming until three months after the 6.48% variable rate cycles off, you could lower the penalty (possibly). Plus, the total taxable interest for the shorter holding shouldn’t be too painful.

I’m not a fan of rolling over I Bonds, but I can see the need for investors who need to raise the cash for a more attractive purchase.

Obvious alternative: TIPS

The one investment most similar to an I Bond is a 5-year TIPS, especially one held in a tax-deferred traditional IRA account. The I Bond can be redeemed without penalty after 5 years; the TIPS matures in 5 years. They are equally safe if you hold the TIPS to maturity. But at this point, the 5-year TIPS has a huge above-inflation yield advantage: 1.66% for a 5-year TIPS vs. 0.4% for the I Bond. This is why I recently wrote that current yields make it “advantage TIPS.”

But TIPS can be a confusing and even frustrating investment, and many investors prefer the simplicity of the I Bond, which has better deflation protection, never goes down in value, and can be redeemed in the year of your choice. I Bonds work much better as a cash alternative and can add to your tax-deferred holdings without creating worries about future required minimum distributions.

I have been buying TIPS aggressively since mid-2022 and I will keep buying the 5- to 15-year maturities as long as real yields continue at high levels. But I will also buy I Bonds in 2023. Inflation protection is a handy thing, as shown in the last two years when inflation suddenly and unexpectedly ran at 7+% annually.

Both investments can work in your portfolio.

• Confused by I Bonds? Read my Q&A on I Bonds

• Let’s ‘try’ to clarify how an I Bond’s interest is calculated

• Inflation and I Bonds: Track the variable rate changes

• I Bond Manifesto: How this investment can work as an emergency fund

• Confused by TIPS? Read my Q&A on TIPS

• TIPS in depth: A primer

• Upcoming schedule of TIPS auctions

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