I Bonds: A rare bright spot for the income investor

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Investors have a natural affinity for income-producing investments. A steady stream of investment income is comforting even if it is not optimal from a total return perspective. Many investors, especially retirees, would gladly trade away some of the anxiety induced by watching a volatile stock market for the psychological comfort from receiving a secure stream of investment income. Even better if that income can keep pace with inflation.

Unfortunately, today’s cash and bond markets have very little to offer in terms of meaningful income, particularly if we are talking about income sources that are also low risk. Nominal yields are dismal. Long gone are the days when depositors could receive 3% or 4% on their cash deposits or 5% on a 10-year U.S. Treasury bond

Yields on bank deposits are now closer to zero than to any meaningful number and have been so for some time. Yields on high-quality bonds, such as U.S. Treasuries, have been at the lower end of their historic range for most of the past ten years, especially for the last several years. Current yields are under 2%, less than half of their long-term average over the past 50 years. Even the broad U.S. investment grade bond market, which includes corporate bonds, is yielding less than 2%. The inflation adjusted yield for all the above is a negative yield.

A full explanation for the low yield environment is beyond the scope of this discussion, but it is fair to say that you can largely thank the Federal Reserve. A recent book by Christopher Leonard hits the mark by referring to the members of the Federal Reserve board as the “Lords of Easy Money.” Monetary policy since the great financial crisis of 2008-2009 has given us several iterations of Quantitative Easing. QE has meant that the Fed has systematically purchased bonds from the major commercial banks and paid for them by making deposits in the banks’ reserve accounts. One result of these actions, and it was intended, has been to drive down interest rates toward zero.

The search for higher yields often has investors looking at alternative sources of income, including high-yield bonds (“junk bonds”), emerging market bonds, master limited partnerships, preferred stocks, and dividend paying stocks. These alternatives all offer higher income, but with a trade-off: greater volatility, greater risk of loss of principal value and, in the case of preferred stocks or dividend paying stocks, potentially lower total returns than a more diversified stock allocation. One lesson for investors is that contrary to what they may think or wish, income does not necessarily mean safety.

One bright spot for investors is the Series I Savings Bond issued by the U.S. Treasury. I Bonds currently offer that elusive mix of high yield and a high degree of safety. I Bonds purchased through April 2022, will pay an initial interest rate of 7.12%. The rate won’t stay at 7.2% for the life of the bond because it will reset every six months based on current inflation. But if inflation stays high, so will the rate. And because the bonds are issued by the U.S. Treasury, the bonds are risk-free in terms of default.

There are some caveats. The biggest drawback to I Bonds is the limitation on purchases. An individual can buy up to $10,000 a year; a married couple can buy $20,000 a year. For the super-wealthy, they may not be worth the effort, but for the average investor with excess cash savings they may be too good to pass up.

Another seeming drawback is that these are 30-year bonds. True, but you don’t have to hold the bond for 30 years. You can look at an I Bond as being something akin to a one-to-five-year CD.

You can’t redeem the bond for the first year. Between years one and five redemption is allowed subject to a penalty of forfeiting the last three months of interest. After five years, you can redeem the bond without penalty. Even if you redeem the bond after one year and forfeit three months of interest, you’ll still have earned a better return than on a current 30-year Treasury.

Lastly, this is a do-it-yourself option. I Bonds are bought directly from the U.S. Treasury at https://www.treasurydirect.gov. You can no longer buy paper bonds and you can’t buy I Bonds through a brokerage account. Some people may not want the extra complexity of transacting and tracking an additional online account. For those who are not bothered by that, this is a relatively easy, no-cost opportunity.

I Bonds may not be for everyone – that’s always a case-by-case determination – but you’ll be hard pressed to find a comparable opportunity in this market environment. This is a rare chance to capture higher returns with little effort or risk.

David Peartree JD, CFP® is an investment advisor with Brighton Securities Capital Management.

This column is a collaborative work by David Peartree and Patricia Foster, Esq.

Patricia Foster is a securities law attorney with substantial experience advising members of the financial services industry.

The information in this article is provided for educational purposes and does not constitute legal or investment advice.