Serious investors should skip the I bond in favor of marketable Treasury debt with a higher yield
Personal-finance pundits love those I bonds. Suze Orman: “The No. 1 investment that every single one of you should have no matter what.” Burton Malkiel: “Absolutely superb.” Last month a stampede for these things crashed the TreasuryDirect website.
After five years an I bond can be redeemed without penalty. The buyer has the option to defer taxation until the bond is cashed in or matures, and usually that’s a smart thing to do. At maturity in 30 years the bond ceases to accrue interest. Interest on I bonds, as on all U.S. government debt, is exempt from state income tax.
Understand what is going on. The government is running a deficit. It covers that in part by printing money to hand out and in part by borrowing from savers. The savers are made poorer with each passing year—a consequence of the fact that the borrower, the inflator and the tax collector are all the same entity.
The grim results are plotted in the two graphs below. The first graph assumes that inflation starts out high—8% over the first year, 5% over the second—and then slumps to a low level that brings the 30-year average in line with bond market expectations.Further assumptions: The buyer is in a moderately high tax bracket, takes advantage of the tax deferral option available on the I bond and opts for a 30-year maturity when buying TIPS.
If real interest rates rise, that option will be worth something. You could cash in the I bond, pay tax on the interest, and use the proceeds to buy long-term TIPS paying better than the current 0.9%.
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