For investors, rising inflation presents a unique problem. The S&P 500 Shiller P/E ratio stands at a lofty 40x, suggesting that stocks may be overvalued at current levels. On the other hand, most fixed-income yields remain low and inadequate to keep up with inflation. As a result, investors are left with few good options to keep their savings from dwindling.
Let’s take a look at an underappreciated government bond, known as an I-Bond, that can help everyday investors hedge against inflation and realize a surprising yield in today’s environment.
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The variable inflation rate component is calculated twice per year based on changes to the non-seasonally-adjusted Consumer Price Index for all Urban Consumers (CPI-U) for all items, including food and energy. The composite rate calculation considers both rates, but the combined rate will never be less than zero (although it may be zero).
|Semi-annual Inflation Rate||3.56%|
|Composite Rate = (Fixed Rate + (2 x Semiannual Inflation Rate) + (Fixed Rate x Semi-annual Inflation Rate))||(0.00 + ( 2 x 0.0356) + (0.00 x 0.0356)) = 7.12%|
Example of I-Bond Composite Rates from the Treasury – Source: Treasury
I-Bonds earn interest for 30 years unless you cash them out. But, while you can cash them out after one year, they lose the previous three months of interest until you’ve held them for at least five years. So, for example, if you cash an I-Bond after 18 months, you’ll only receive 15 months’ worth of interest, although that may still be better than savings!
The relative benefit of I-Bonds is even higher if inflation continues to rise—a theory that’s no longer fringe. Federal Reserve Chairman Jerome Powell recently warned that inflation could continue to grow next year due to the impact of the Omicron variant, which could further disrupt supply chains and exacerbate current challenges.
I-Bonds are also superior to other inflation-protected securities, such as Treasury Inflation-Protected Securities (TIPS). Since I-Bonds have a guaranteed real (e.g., inflation-adjusted) yield, you will always earn at least as much as CPI inflation. By comparison, TIPS are trading at negative real yields thanks to low Treasury yields.
Investors may want to consider I-Bonds for some of their emergency funds since they’re 100% safe and completely liquid after a year. Of course, they also offer a better yield than a savings account and protect your emergency funds from the ravages of inflation. Other investors may use them for part of their fixed-income retirement portfolio.
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