D3sign | Moment | Getty Images
It’s not hard to figure out why. These U.S. government-backed bonds pay a fixed rate throughout the life of the bond plus an inflation-based that adjusts every six months based on changes in the consumer price index.
Thanks to sky-high inflation, such bonds offered an interest rate of 7.12% at this time last year. The rate jumped to 9.62% in May 2022 before receding back to its current rate of 6.89% — good on bonds issued through the end of April 2023.
To say investors haven’t been able to get enough of I bonds is true metaphorically but wrong factually. You can only purchase up to $10,000 worth of these bonds per person per calendar year. That is, unless, you use your tax refund money, which allows you to purchase an additional $5,000.
That means if you’re expecting a big tax refund this year, you can maximize your investment in I bonds. But that doesn’t mean it’s necessarily the best move for you.
“I don’t think it’s a bad investment, but it’s certainly not as attractive as it was before,” says Justin Halverson, a partner at Great Waters Financial. And depending on your financial situation, investing in them “shouldn’t be your top priority,” he says.
Investors find I bonds attractive because they provide a helpful way for your portfolio to keep up with inflation. Rates on these bonds adjust each November and May. The rate you receive is locked in for six months after the date of your purchase.
These bonds come with some key risk protections, too. Unlike other types of bonds, I bonds aren’t available to buy or sell on the secondary market. That means they’re not susceptible to price fluctuations based on investor demand or movements in interest rates. (Bond prices and interest rates move in opposite directions.)
And like Treasurys, I bonds are issued and backed by the U.S. government, meaning there is next to zero chance of default.
When inflation was running rampant and interest rates were low, I bonds looked especially valuable. Last May, when I bonds were paying 9.62%, a 1-year Treasury paid 2.1%.
That dynamic is changing, points out Halverson. The Fed has since embarked on a series of sharp increases to interest rates with the goal of slowing inflation. Not only has that made more traditional bonds more attractive — a 1-year Treasury currently yields 5.03% — but it can dampen I bonds’ appeal.
“The hope of the Fed and the rest of us is that they’ll get inflation to cool. If that happens, that makes I bonds less attractive as time goes on,” says Halverson.
Plus, I bonds come with some tricky rules. For one, they can’t be redeemed for a year after you purchase them, making them a bad place to stash cash you may need in a hurry. If you redeem them within the first five years of purchase, you’ll owe a penalty equal to three months’ interest.
And you won’t be able to buy these using your brokerage account. You have to buy I bonds online from the U.S. Treasury, an experience that some have compared to an online version of the DMV.
If you’re aware of the intricacies surrounding these bonds, they can still be an attractive holding for certain types of investors. After all, it’s hard to argue against he appeal of protecting your portfolio from inflation, which over time erodes the value of your investments.
But before you consider plunking any of your tax refund money into I bonds, it’s important to make sure you have some other bases covered first, financial advisors say.
1. Pay down high interest rate debt
“If you have any debt, particularly credit card or other adjustable-rate debt, paying that down needs to be priority no. 1,” says Halverson. “The cost of credit has skyrocketed.”
Think of paying down any debt you have as a return on an investment. In other words, paying back a loan that charges 5% interest is the equivalent of earning 5% on an investment. Put in those terms, paying off your credit becomes a no-brainer compared with investing in I bonds. The current I bond rate of 6.89% may seem tempting, but it pales in comparison to the 19.94% average APR on credit cards.
2. Build your emergency fund
If you don’t have some cash stashed away to cover an emergency, an unexpected bill could derail your financial plans or force you into debt. Most financial advisors recommend setting aside the equivalent of three to six months’ worth of expenses in a high-yield savings account.
Even though I bonds, like cash accounts, run an extremely low risk of losing money, “your emergency fund should not be in an I bond,” says Kendall Meade, a certified financial planner at SoFi. “This is money that you want to be able to access at any time, and you can’t access I bond money within a year. And between one and five years you’ll pay a penalty.”
3. Invest for the long term
While the rules make I bonds unattractive for the very short term, their return potential means they don’t make sense for the very long term, either, says Meade. “Even if it’s at 6.89% now, that rate is likely to go down,” she says. “If you have a longer-term need, that’s something where you think, I can probably do better in stocks.”
For someone who is looking for an intermediate-term “safety position” — that is, one that will appreciate with very little risk of losing money — I bonds could be an appropriate choice, says Halverson. But if you’re investing for the long term, now is a great time to boost your contributions to your retirement accounts.
“Right now you have an opportunity to invest in stocks while the market is down and likely set to recover sooner than later,” he says. “Taking that money and investing long-term is going to pay you more.”
Get CNBC’s free Warren Buffett Guide to Investing, which distills the billionaire’s No. 1 best piece of advice for regular investors, do’s and don’ts, and three key investing principles into a clear and simple guidebook.