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Why I Bonds? A Possible Place for Extra Cash

As gas and food prices hit high and the Fed responds last week by increasing interest rates[1] for the first time since 2018, inflation is top of mind for many clients, and some may be wondering where to put extra cash. For clients who want to keep a portion of funds in cash as a hedge against inflation, I Bonds may be worth considering. Whether cash for an emergency fund, savings for an upcoming purchase, or money that clients do not intend to invest, but still want to earn interest on in the meantime, below is a comparison of options (listed least to greatest potential for Interest).

1. Savings Account

The most common place for excess cash to land is in a savings account at a person’s primary bank (usually a brick-and-mortar bank with physical branches). These accounts are great for ease of access and flexibility, however, the interest rate on these types of accounts are (at the time of this writing) averaging around 0.06% (this includes both online only banks and brick-and-mortar banks).

The downside for keeping cash in your savings account is that you will not be getting the highest interest rate possible. However, if your primary objective is to have access to the cash as easily as possible, keeping the cash in your savings account could be a solution for you. You may find it easiest to keep the cash in your savings account if you know you will need access to the cash in the immediate future (for example, within the next year), rather than having to set up additional accounts.

2. High-Yield Savings Account or Money Market Account

These accounts can be a great alternative to the standard savings account. At the time of this writing, the best interest rates on these accounts are 0.50% to 0.75%. This type of account gives you a little more return potential while keeping the funds very liquid. You will likely need to set up an account at an online bank if you choose to use this type of account.

This type of account can be a good place to keep savings that you anticipate using in the short to intermediate term (1-3 years), but do not have an exact date where you know you will need the funds. For example, if you are saving up for a down payment, but do not know exactly when you find your ideal home, keeping cash parked in high-yield savings account could be a good option for you. There are no penalties for taking funds out of these accounts.

3. Certificates of Deposit (CDs)

CDs can be great for an investor who is looking to earn a fixed rate of return over a certain period of time. They typically offer better returns than savings accounts (currently about 1.00% to 1.40% APY on 2-year term CDs), and can be a good place for cash that would otherwise be stagnant over the term of the CD. However, there can be drawbacks to investing in CDs.

One of the main drawbacks is that it can be difficult to access money from a CD if an unexpected need arises. There are often early withdrawal penalties, which could be sacrificed interest or perhaps loss of principle. There are “no penalty” CDs, but returns are usually lower due to the increase flexibility. In addition, locking up money at a fixed rate over a period can expose you to inflation risk.

4. Series I Savings Bonds (I Bonds)

I Bonds are a unique savings instrument that can make a lot of sense for an individual in certain situations. An I Bond is a 30-year non-marketable (cannot be bought and sold on secondary market) security. Generally, you can only purchase $10,000 of I Bonds per Social Security number per calendar year, with an additional $5,000 that can be purchased using your Federal Income Tax refund. The earnings rate for the bond is a combination of a fixed rate (set at the time of purchase) and a variable semi-annual inflation rate (which is re-calculated every six months). The earnings on the bond are compounded semi-annually. Once you purchase the bond, it is only redeemable after 12 months, and if redeemed before holding for five years, there is a penalty of 3 months interest.

Why should someone be interested in investing in I Bonds? Simply put, they are a great hedge against inflation and are backed by the United States government. While TIPS funds (mutual funds that invest in Treasury-inflation-protected securities) respond only to unexpected inflation and are marketable, I Bonds have a variable component that is directly indexed for inflation using the Consumer Price Index.

These rates are adjusted every six months in May and November, but currently, any bonds sold between November 2021 and April 2022 earns an interest rate of 7.12%![6]

We would not recommend putting any cash that you might need in the next year into I Bonds, but if you have cash that you want to keep around for the next 1-5 years, and especially 5-30 years, that you may not want to invest in the market, I Bonds can be a great option to consider to protect the purchasing power of those funds.

I Bonds must be purchased by going directly to the United States Treasury website.

See Sources

[1] “The Federal Reserve raises interest rates for the first time since 2018”

[2] “What is the average interest rate for savings accounts?”

[3] “Best money market accounts for March 2022"

[4] “Best CD rates for March 2022"

[5] Treasury Direct: "Buying Series I Savings Bonds"

[6] Treasury Direct: "Buying Series I Savings Bonds"

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