Bridget Sullivan Mermel CFP(R) CPA
Buying I Bonds Before Rates Drop? What's Best For You?
Buying Series I Bonds before the rates drops make sense for many people. The rate changes on May 1 for new purchases, but in 2023, you need to get the I Bonds bought before April 27 to get the existing 6.46% annualized rate.
Bridget Sullivan Mermel and John Scherer talk about why the interest rate on I bonds is expected to drop, and why there might be a silver lining.
The variable rate is tied to inflation, which is not as high as it has been. But the fixed rate is important, especially if you plan to hold your I Bonds for a long time. You can hold Series I Bonds for up to 30 years. The longer you plan to hold on to I Bonds, the more important that fixed rate is.
02:15 Rate predictions
04:13 Considering the fixed rate
09:10 Market timing
11:00 Keep it in perspective
#acpmemberwisdom #financialplanning #ibonds
Here's our video that covers when I Bonds are NOT appropriate:
The Series I Bond Interest rate fell before. Here's the video that explains how the rolling interest rates work: https://youtu.be/8xwkW1rvHJU
This video describes the plusses and minuses of I bonds: https://youtu.be/AYr_7L6OaCs
John's firm website: https://www.trinfin.com
For advisors around the US: https://www.acplanners.org/home https://www.acplanners.org/home
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John: I bond rates are changing, effective May 1. In today's episode of Friends Talk Financial Planning, you'll learn what you need to know to make the best decision for you in making sure you lock in the rate that's highest and makes the best sense for your situation. Hi, I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.
Bridget: And I'm Bridget Sullivan Mermel, and I've got a fee-only financial planning practice in Chicago, Illinois. And before we go any further, John, let's ask people to subscribe. That helps us with YouTube and helps more people find out about us.
John: That's awesome.
Bridget: All right. So I'm really excited about this episode. We've been talking about I bonds for a long time. Now we're going to talk about how the rate is determined. And inflation is coming down, so everybody's predicting that the return rate of I bonds is also going to go down.
John: That's right.
Bridget: And that the date for that is as of May 1, but it's important to know the last date you need to buy I bonds in order to get today’s rate.
John: Yeah. So the rate changes based on inflation every May 1 and November 1. But this year, just the way the calendar falls, if you're going to buy them and get today's rate, you've got to buy them by April 27, which is a Thursday. It’s kind of a weird thing, but that'll be one of the takeaways. In short, if it makes sense for you to buy at today's rate, you need to get it done by April 27. The question is: does it make sense for you to buy at today's rate? What are we even talking about here?
It's interesting, Bridget. We've been talking about I bonds for about three years or so now. Rates have gone up and up. Last year, people were getting over 9% on your I bond. If you bought them here starting in November, the rate is north of 6%, around 6.5% or so. Golly, that's a really good rate of return. November until May, if you buy in that time frame, you're getting that 6.5% or so return. And as you just said, inflation has been cooling off, so the expert predictions are that because the inflation rate is going to be down, the I bond rate is going to be in the 3% range instead of up in the 6% range.
You go, “Okay, wait a minute.” So one of the opportunities is to say, “Listen, if I want to buy an I bond, I can put up to $10,000 per person into it. (You can only buy $10,000 per year right per person. So it's not like you can put in as much as you want to) If I'm going to make that purchase, if I do it here in April before the 27th, I know that I'm going to get that November to May rate, which is north of 6% and lock that in.” So that's one opportunity is to say, “Hey, you can still get today's rate, and we think it's going down in the future.”
Bridget: And you get the rate for the next six months.
Bridget: So if you buy on the last possible date, April 27, then you still get the 6.47%, approximately 6.5% rate for the next six months.
John: That's right.
Bridget: So when you're talking about locked in, that's locked in.
John: Right. And it's sort of like CDs. A lot of people are familiar with buying CDs. If I buy I bonds now, I know I'm getting that 6.5% rate. I don't know what I'm going to get when it comes to May and there's going to be a different rate, but I'm locked in for that time period.
Bridget: Yeah, that's exactly right.
John: So on the surface, it seems like it makes sense if it fits for you, and we'll link back to our previous episodes on I bonds. There are a lot of positives, there're a few drawbacks, but if you go, “Listen, it makes sense for me to buy I bonds,” you know, the rate you're going to get today is north of 6%, and that'll stay in place for the next six months. We think that the rate is going to go down in the future.
It seems pretty certain that the inflation-based rate is going to go down just based on how they use monthly data. We can see the writing on the wall with that, but that's not the entire story when it comes to I bonds. We've got that inflation rate that we've been really focused on that, but you had a really good point, Bridget, about the other component of these I bonds.
Bridget: The other component of the I bonds is the fixed rate, and it's a little more mysterious. There's an actual formula for the inflation part of it, the variable rate, so people can try to figure it out, but they don't publish exactly how they come up with a fixed rate. And the fixed rate is important because you get that fixed rate as long as you hold that I bond, up to 30 years. So you always get that.
And so, there're people who bought I bonds back when inflation was higher and prevailing interest rates were higher, and they were getting up to something like 14% on their I bonds, while everybody else was getting 9%. So there's an advantage to having I bonds with a higher fixed rate. And they don't publish this, but it seems to me that the fixed rate is at least somewhat based on the prevailing interest rates for, something like T bills.
John: It doesn't match up perfectly, but it sort of runs in a similar curve type of a thing.
Bridget: Exactly. And it also does not seem to be about trying to get more inflows into the I bond system. So inflows were at an all-time high last term, yet they still increased the fixed rate. And so that to me says that they really are trying to tie that fixed rate with prevailing interest rates. That's my theory. Again, they don't say this, but that's my theory. And because prevailing interest rates are going up, I think the fixed rate might go up.
John: It's really interesting that for a long time back in the teens, the fixed rate was 0% or 0.1% or something that was really negligible. And for a long time, and the inflation was really low, so nobody was paying attention. We weren't talking about them or recommending them. Then a couple of years ago that inflation started kicking in. The fixed rate was still basically nothing, if not actually nothing.
And so, as inflation had kicked in in 2020/2021 a lot of people said, “Look at this great rate that you can get.” And I'll tell you, it's one of the things I was thinking about for our discussion here today. Usually if you say, “Listen, I want a really good interest rate, and I want to have safety,” those two things do not correlate. Risk and return. If you're going to get a higher rate, there's got to be some catch in here. And this is one of the very few places where that isn't the case.
Bridget: Right now.
John: Right. But it's backed by the government. It’s fixed. You know what you're going to get. The caveat is you can't put as much money as you want to into it. And you can't get it out right away in the first year. I mean, there are some of these drawbacks, but it is high returns with guarantees. Yes, there's no big gotchas, unlike most of the other things that I hear about anyway.
Bridget: But historically, they haven't been as attractive because inflation has been low.
John: We were just looking at some of the data. There have been years or six-month periods when the return was zero. No fixed rate. Deflation. It's not going down, but you're literally getting zero. You go, “Okay, that's not very appealing on things.” Lately, we've had those things ramping up. And going back to that fixed rate. For a long time, fixed rates were nothing or basically nothing.
A year ago, we were getting something in the nines for interest rate, 9.5% or something like that. I mean, some crazy number. That's awesome. November, inflation cools off. Hey, the new rate is going to be in the sixes, which is what you're getting now. And then, sort of by surprise, the Fed came out and said, “Hey, instead of zero now we're getting 0.4% on the fixed rate. So if you buy your bond now, you get that 0.4% fixed rate on the thing.
Bridget: As long as you hold it for up to 30 years.
John: I mean, going forward on that. And it's really interesting when you asked, “How do you think about that?” To your point, Bridget, I hadn’t thought about that before. Our conversation here is maybe that fixed rate is going to go to 0.5% or to 0.6% or to 1%. We have no idea what that comes out to be. It might go, yeah, the variable rate in May is going to be three something, but if the fixed rate is one or one and a quarter or who knows what the number is, that might be really appealing to have that purchase be done in May. Yes, I'm going to get a lower variable rate. My inflation protection has gone down because inflation has gone down, but I've got that higher fixed rate for the long time. Or the fixed rate could go down, it could go back to zero; we just don't know that.
Bridget: Right. And one of the basic concepts of modern portfolio theory is don't try to time your investments. And so, even though I'm evoking jargon, I kind of go back to that. And if you have the money, invest it. If you have the money, act now. Statistically, that's what works out the best for people. And so, for me, I don't want people to borrow money to put it into an I bond. I don't want them to not put money into a Roth, if they can, and instead put it in an I bond.
So I don't want people to try to scrounge around and summon up some money just to put it in an I bond before the deadline, because it's not like I bonds are going to become bad afterwards; there're some advantages to waiting. But I also don't want people to say, “Oh, she says the fixed rate might go up. I'm going to wait because I want the fixed rate.” I don't know. And so, again, the basic principle that I fall back to is it's kind of like eat right and exercise. Okay, I'm not going to stop exercising…
John: ...because I can predict the future.
Bridget: That's exactly right. The basic rule is invest the money you have to invest, even if things go up and down. If you've got the money and you want to make the investment, do it, but don't go to extreme lengths to come up with the money. That's what I would say.
John: I really appreciate that. The other thing that we talk about a lot with folks is what are we trying to accomplish? That's the key thing for everybody. But also, what are we talking about in dollar terms? If I see $100 on the ground, I'm going to pick it up. But we're talking about a $10,000 maximum annual investment. So the most that I could put into an I bond right now if I want to buy and get this current six plus percent rate, with the 0.4% fixed rate, I can only put in $10,000 if I have that, and it fits my goals.
If I could wait until May and if I could get an extra 1% return, let's say, on $10,000, that means $100; an extra 1% is $100 a year. Again, I'll take it if somebody wants to give $100. We'll put the Venmo at the end of this, but it's not like saying, “Oh my gosh, this is changing my life.” It's one of those things, yes, let's take advantage, let's be smart about it, but we're not making just gigantic decisions when it comes to what the results are. And then the other thing I just wanted to point out, too, is just because there is a $10,000 limit does not mean that you have to buy $10,000.
John: You could choose to say, “Well, listen, I think it's appealing now I've got some money, I'll put in $5,000 today.” And then if it becomes appealing again in July or in October or next November, you could put in another $5,000 and you could sort of diversify with that, if that fits.
Bridget: Yeah, I think with that it's a great time to wrap it up. I'm Bridget Sullivan Mermel, and I've got a fee-only financial planning practice in Chicago, Illinois.
John: And I'm John Scherer. I've got a fee-only financial planning practice in Middleton, Wisconsin. Both Bridget and I are taking on new clients ourselves. We'd love to hear from people, but we're also members of the Alliance of Comprehensive Planners, so if you like what you hear on our show, you can check out acplanners.org to find an advisor in your area that thinks like we do.
Bridget: And don't forget to hit that subscribe.
At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.