I-Bonds helped many investors avoid the bloodbath in the broader equity markets over the past year with their nearly 10% risk-free yields. But with inflation slowing down, these interest rates are on the decline, and the bonds have become less attractive. As a result, investors may want to look toward other fixed-income products for yield.
Let’s examine why I-Bonds have become less attractive and what alternatives to consider.
Don’t forget to check our Fixed Income Channel to learn more about generating income in the current market conditions.
Why I-Bonds Are Less Attractive
Series I Bonds are government bonds offering investors a combination of a fixed interest rate and an inflation rate. These interest rates reset every six months on May 1 and November 1 based on the consumer price index (CPI). While the bonds have a 30-year time horizon, investors can redeem them after 12 months with a modest interest rate penalty.
I-Bonds caught investor attention last year when rising inflation caused their yields to soar. These yields rose from 1.68% in March 2020 to 9.62% in September 2021, providing an unprecedented risk-free return. But in March 2022, interest rates reset to 6.89% through April 30, 2023, following the slowdown in inflation (CPI).
Since investors must hold I-Bonds for at least one year, purchasing one now means earning six months at 6.89%, but the remaining six months might be lower. In addition, selling I-Bonds before five years results in losing the last three months of interest. As a result, investors may have better options for low-risk yield in today’s market.
Be sure to check out this article to see if I-Bonds should fit in your portfolio.
I-Bond Alternatives to Consider
Treasury bonds are offering historic yields in today’s market. For example, 10-year Treasuries provide an attractive 3.79% yield. And since the federal government backs them, these bonds are just as low risk as I-Bonds. The easiest way to gain exposure is via exchange-traded funds, like the iShares 20+ Year Treasury Bond ETF (TLT).
Municipal bonds are also attractive for high-net-worth investors looking for low-risk investments. Since these bonds usually aren’t subject to federal or state income taxes, they offer attractive after-tax yields for those in higher tax brackets. And currently, some of these bonds offer 2-3% before-tax yields in today’s market.
Finally, corporate bonds fell sharply throughout 2022 as rising interest rates pushed yields higher and prices lower. But in 2023, the market could start to see a turnaround if inflation diminishes and interest rates stabilize. In particular, investors could benefit from attractive 4-6% yields plus potential capital gains as prices recover.
The Bottom Line
I-Bonds provided investors with a nearly 10% risk-free return last year, but these rates are starting to fall as inflation slows. As a result, investors may want to look toward more conventional fixed-income investments that could start to recover and offer higher yields, including Treasury bonds, muni bonds, and corporate bonds.
Take a look at our recently launched Model Portfolios to see how you can rebalance your portfolio.
