Does looking at your wallet these days give you a bit of a headache? Don’t bother checking WebMD: it looks like you might be suffering from a stock market boom.
With inflation at 8.6%, its highest in 40 years, and interest rates rising sharply, investors are looking for safe havens.
Enter savings bonds. Since they carry little risk, you would normally expect a modest return on investment. But when inflation and interest rates rise, they approach average stock returns, making them a tempting alternative in a bear market.
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Bonds are like a loan to the government
Essentially, a US savings bond is a debt security issued by the US Department of Treasury – or in simple terms, it’s a loan to Uncle Sam. You can buy them online at the TreasuryDirect.gov website. of the US Treasury Department.
A savings bond pays interest until it “maturates” in 30 years, and you can cash in without penalty anytime after five years.
When you redeem your savings bond, the government pays back the amount you lent it, plus interest, like a certificate of deposit.
There are currently two types of US savings bonds available for purchase – Series EE and Series I.
EE-Series US savings bonds are also called “patriot bonds” and you buy them at face value. This means that if you want to buy an EE savings bond for $50, you pay $50. The interest you earn on your Series EE bonds is compounded semi-annually and is added to the face value of the bond. When you redeem EE Savings Bonds, you receive the full face value plus your interest on top.
Series EE Bonds currently offer a fixed interest rate of 0.10%. However, if you hold your EE bond for 20 years, the government will make a one-time adjustment to ensure it is worth double what you paid, regardless of your interest rate.
I-series US savings bonds protect against inflation, which is what the “I” stands for. You buy Series I bonds at face value and earn interest compounded semi-annually for up to 30 years, plus additional income based on the rate of inflation. In a deflationary economy – like during the Great Recession – your rate of pay could potentially be lower than the fixed rate, but it will never drop below zero, so your initial investment is safe.
The Series I bond interest rate is made up of two components: one for the fixed rate that applies for the entire term of the bond and one for inflation, which is adjusted every six months. The current rate as of July 1 is 9.62% — entirely based on the inflation component, as the fixed rate is currently 0%.
What makes it such a safe investment
Bonds in general are an effective tool for portfolio diversification. Because they have a low correlation to other investment asset classes, when you add them to your portfolio, they can help cushion the blow of stock market crashes.
To help you spread your risk, financial advisors traditionally recommend the 60/40 investment rule – 60% stocks and 40% bonds. As the 60/40 rule has lost ground in recent years with bond yields at rock bottom, with rising inflation, those low bond yields are turning around.
Savings bonds are among the safest types of investment. To lose your money, the government itself would have to collapse. Since that’s unlikely to happen, your biggest risk would be earning no interest on a Series I savings bond if inflation turned negative.
In addition to diversifying your portfolio, savings bonds can also supplement your retirement savings. With Series EE bonds and I bonds, you can invest up to $10,000 in each type per year, which means more tax-deferred savings beyond your IRA or 401(k) contribution limits. ).
It’s not all upside down, though
That said, there’s one important thing to consider with savings bonds: they’re temporarily illiquid, which means the money you invest isn’t immediately available if you need it.
You cannot touch the money from your savings bonds in the first year. And if you redeem it before five years, you’ll sacrifice three months of earned interest. This means that if you redeem a bond after 18 months, you will only earn 15 months of interest.
Savings bonds are more for stable, long-term savings than for unexpected emergencies. You should already have built up an emergency savings fund, ideally in a high-yield savings account.
When you have a lump sum of money that you want to invest over a longer period of time, savings bonds can help balance out the risks associated with the stock market. But because of the lower yields, it’s usually not a good idea to put all your eggs in the savings bond basket.
When it’s time to cash out
To get the most out of your savings bonds, hold them to maturity to earn compound interest.
In February 2022, the government reported that more than $26 billion lay dormant in unredeemed and matured savings bonds. If you have money tied up in old savings bonds, you can search for it on TreasuryHunt.gov.
Remember that you will have to pay federal taxes on the interest you earn. You can choose to pay taxes on the interest you earn each year, or you can pay them all at once when you cash out, relinquish the property, or when the bond matures.
One loophole to avoid federal taxes on your interest earnings is to use them for higher education expenses for yourself, your spouse, or your dependents. There are a few eligibility requirements, but if you qualify, it’s an easy way to increase your ROI.
Hope this helps settle your stomach when you think about your wallet these days. And if not, maybe it’s time to see what WebMD has to say.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.