Episode 25: Are 7% Bonds Too Good to Be True?

Isaac Wright: Well, welcome back to Wright Money Tips. Again, we’re in the front side of 2022 and wanting to bring some meaningful topics to the table. And this one, I think you’re going to want to pay attention to as well. Because right now, as you already know when you go to the grocery store, when you go to the gas pump, inflation is upon us.
And it’s been this way now for quite some time. Not really sure if it’s going to slow down anytime soon. And then on the flip side, you have money sitting at the bank. That’s paying you well less than 1%. So, you’re really not keeping up with cost of living. How can you have a conservative way of trying to keep up with inflation?
Well, there is something called a series I bond that we’re going to talk about today and that bond is currently paying over 7%. But there are some pros and cons. And on today’s program, that’s what we’re going to focus on. And first I want to introduce our guest of the day, Aaron Reed. Aaron is one of our advisors here at Financial Dynamics.
Aaron, you and I have had this conversation and we have had people reach out to us about this. And so really today, I want to summarize just some quick points about what an I bond is, what are some opportunities around that, and then some things to be aware of. And of course, if you have any questions at any point on today’s show about what an I bond or any other investment that can help you improve your cash, the interest rate that you have at the bank, we’re here to help. But we’re going to focus on that today.
Aaron, why don’t we start off and talk a little bit about just generally what an I bond is and maybe how it could potentially fit for somebody because 7% plus is not a bad interest rate today.
Aaron Reed: Absolutely. One of the biggest needs of our clients are everybody wants to get, you know, a good interest rate. They want to get a good return. They want it to be safe. They want it to be liquid. Those three things don’t necessarily always go together. But these I bonds can be a very good fit for a client. You know, of course, you can only put a certain amount into them each year, so it may not change the world for them financially, but it can definitely be a good part of a balanced portfolio.
Isaac Wright: So, basically, on an I bond chassis, you’re able to purchase something directly from the U.S. government. I believe it’s May and November, every six months, you can go in and of course, you can do it right now as well, and I think it’s still a good opportunity. But what’s the maximum you can put into an I bond and how does that work?
Aaron Reed: So, the most you can put into an I bond annually is $10,000. And the way the interest rate credits is, like you said, between November and May. It adjusts off of the consumer price index. That’s how they come up with what they’re in currently, like you said, it’s 7.12%.
Isaac Wright: Well, and here’s the deal is this, I think we can all find when we go to the stores and especially if we look at large purchases like vehicles, I can’t believe the cost of a new car today versus a few years ago. Granted, they may have a few extra bells and whistles, but it’s like a hundred thousand dollars for a basic car.
Anyway, I think when it comes to an I bond. Every six months, so that you get that reestablished rate, so it may mean that you, every six months could get a rate higher or lower. But generally speaking, I think you and I have agreed on this, inflation is at least here to stay for at least the duration of what we forecast of another one, two years. We may see some tightening from the Fed and things like that. Rates are cooling things down. This $10,000 that somebody can put into an I bond and that’s per person. You’re at a point where we’re talking about the fact that it may not be life-changing money, but you know, 7% on 10,000 bucks is $700 of interest. How much money would you have to leave at the bank to make $700 a year in interest?
Aaron Reed: Quite a bit.
Isaac Wright: So again, just things to keep in mind here. Now, also, when it comes to an I bond and it’s something that you’re purchasing directly from the U.S. treasury. There’s a website you have to go to because this is not an open market type of bond. You’re not having to worry about having to take on a lot of risks. So, let’s talk about if you have somebody that’s in a position where they have money and say, what’s kind of the general thought you have as far as maybe setting up an I bond and also let’s talk a little bit about some of the scenarios that they have to just make sure they know about how long they have to keep the I bond. Can you explain a little bit of that to our listeners?
Aaron Reed: So, in order to purchase an I bond, you have to go on the Treasury Department’s website, create an account and basically you have to do it yourself. Now, once you get your account set up and everything, it’s probably a little bit easier going forward.
The initial setup might be a little, you know, for some someone who’s not super tech savvy, but it should still be pretty basic. If you can set up an email account, you can probably go and buy an I bond. They’re 30-year bonds, but you don’t necessarily have to keep them for 30 years. You’re not going to get hit with huge penalties. You do have to at least commit to 12 months. You don’t want to look at an I bond if you think you’re going to need to access those funds within 12 months.
Isaac Wright: So, anything financially you put into an I bond, you definitely need to have at least a 12-month commitment.
Aaron Reed: After the 12-month period, you can cash your bond in, if you would like, and you would pay a penalty of three months worth of interest. So, that’s not a huge penalty. You know, it’s still fairly liquid. You may miss out on a little bit, but if you need to get the funds after 12 months, it’s not the end of the world to pay three months interest penalty.
After five years, there’s no penalties at all. You can get all your money back out of it in five years or after five years, if you want. So, the liquidity is pretty good, especially considering the return and the safety that you get with it.
Isaac Wright: So just kind of listen to what Aaron is saying here, basically.
As long as you’re okay with having some money tied up for at least a year, and maybe between one and five, you have to have a three-month interest penalty payback. I want you to listen to this because even if you have an interest rate at 7% and you have to pay a penalty of three months of interest after one year, you’re still going to net five plus percent in a return.
Again, when we’re talking about money you have at the bank or money sitting in cash. As a very low risk, again, backed by the faith of the government, you’re at a point where 5% on that 10,000, even if you had to pay the penalty of 500 plus dollars of interest, most of you were making 0.1% or 0.2% in your money market or your savings account. Again, we can’t guarantee it’ll pay 7% every six months, but on those renewals in May and November, you can adjust this.
Let’s say for whatever reason, and I think this is a good thing, you and I talked about this. Let’s say 12 or 18 months from now, inflation goes to zero, highly doubtful, but let’s just say it does. And the bond pays zero. But you’ve made 7%, maybe the following six months as a hypothesis. You’ve made 6% or 5% or maybe 8% or 9%, depending on what inflation is and all of a sudden inflation drops, what can you do?
Aaron Reed: So, at that point in time, you could, you could reposition that asset into something that will be a little more in tune with what you need and the economic situation at the time. They’re very flexible. You’re not locked into this thing. It’s pretty liquid as far as safe investments go.
Isaac Wright: I think it’s good for people to understand this because again, if you have to go to the website and put money in, on your own accord, through the Treasury Direct website, it doesn’t mean that you can’t go back and get it. So, as far as maybe piling up a little bit of money that can keep up with inflation relative to your overall net worth. If you have any questions related to that, Aaron, myself, we’re here to help you. But these are things that I just want you to be aware of because sometimes, and we’ve had tons of questions about an I bond, and some people just literally don’t want to go to the website and set it up. I mean, these are things that if we can get through these hurdles, it’s a significant amount of interest.
Let’s say you’re married. You know, you and your wife, Aaron. You could put 10,000 in and your wife could put 10,000 in. That’s 20,000. And I believe you can actually add another 5,000 if you get a Federal return on your taxes. Now we don’t necessarily sometimes see that, but I’m just telling you, and all of you really. Imagine if you had 20,000 and next year you put another 20,000. You may have$30,000 or $40,000 of inflation adjusted interest, and you can back that money out of this after 12 months. That’s a pretty decent opportunity.
Let’s talk about why you wouldn’t do it. If you only have $10,000 in your emergency fund and you obviously don’t want to put all 10,000 in an I bond because you would have zero emergency money.
Aaron Reed: It’s not that liquid. It is safe, but it’s definitely not emergency fund money.
Isaac Wright: One other thing, just as a caveat, depending upon your income, the money that you’re earning in the I bond potentially could be used for educational purposes. And you get a state tax deduction, I think potentially as well.
Aaron Reed: Yep. So, there’s some details and some ways that you may or may not necessarily qualify depending on your situation. But it can be used if you can avoid the tax if you use it towards a qualified educational expense.
And speaking of the tax on these things, I think one of the coolest features about these bonds is the tax treatment of them. Because it’s one of the few or one of the only ones I can think of right off the top of my head, where you can choose to defer the interest, defer the taxes on it. Or you can choose to go ahead and pay as you go.
You can pay it each year, or you can defer it just like an IRA or an annuity. You can defer those taxes depending on what makes sense for you and your tax situation and your income. It’s just one more feature that this thing has that you can make that choice. Not too many other vehicles let you choose how and when you want to pay the tax on it.
Isaac Wright: Well, ladies and gentlemen, I really hope today was at least helpful in terms of maybe trying to find some opportunity and options with cash that you have on hand. If you have any concerns about the amount of cash, maybe you have piled up here over the recent, let’s call it a couple of years where interest rates have basically been zero.
This is just one option. I wish you could put more money into an I bond. And of course, there’s some limitations. We’re also able to provide you some advice on how to be able to handle some of that other cash on hand. We have many opportunities there on that front that we feel equally as good about that you can put a lot more than 10,000 into.
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All of this today, I think is going to be very well suited for somebody that needs a little education on just ways that they can position some cash. Aaron, it’s always a pleasure to be able to talk to you. We’ve had a lot of questions on. And I can’t imagine it’s going to slow down.
Aaron Reed: It’s a big topic. You know, a lot of my clients, I feel like are sitting on probably more cash than they have been in a long time. And they’re really nervous about exactly what to do with it. They don’t want to get left behind with inflation going up. They don’t necessarily want to dump it in the market and take a lot of risks. So, it’s definitely something we talk about a lot, and I appreciate you having me on today.
Isaac Wright: Absolutely, man. Look forward to talking to you soon. Take care until our next episode.