iBonds and interest rates; a look back

November 15, 2024

To their credit, iBonds do have a clever name. They have the "i" tucked on there for "inflation," and they are riding the coolness coattails of Apple products. So the naming team deserves credit!

For the most part we don't recommend iBonds, but they're not confined to the annuity-whole-life-insurance bin of despair either. They were popular in 2022 given their 9%+ rates of return. Let's look at them now, and also what can be learned from the past two years.

iBonds have a unique construction in that the rate changes every six months, largely in sync with inflation. So they accomplish a dedicated purpose - they are an inflation hedge. In our complex world, a simple product that serves a dedicated purpose gets kudos. They have the benefit that the counterparty is the United States government, and therefore doesn't have lots of other unstated motives. (This can be a problem in the corporate bond market.)

So did people make that juicy, risk-free 9%?

Yes sort of.. and then quickly no.

To parse that sentence, the "sort of" is because the interest rate is federally taxable if the product is held in a taxable account. So you have to take the 9% down by your federal tax rate. This is better than CDs or money markets held in taxable accounts; those products are federally and state taxable.

And the "quickly no?" That is because as inflation fell, after the first few payments the bond coupons reset to lower levels. The bonds that were bought in October 2022, while initially paying over 9%, are now paying 1.90%. Apparently that is above inflation, although don't tell anyone who actually goes to a grocery store.

This is called interest rate risk, and I was warning clients in 2022 and 2023 to take it seriously. It affects short-term bonds, CDs, and money markets in particular. It's important to recognize the collapse in payments from the October 2022 iBond just two years later. It was nothing like locking in a 30-year Treasury bond in September 1981 above a 15% rate.

Here is the full chart of iBond rates. The rate depends on the date the bond was purchased, as a portion of the coupon is fixed for the life of the bond:

https://www.treasurydirect.gov/files/savings-bonds/i-bond-rate-chart.pdf

Dan Cunningham

Sources: iBond 2022 rates and tables:
https://www.treasurydirect.gov/savings-bonds/i-bonds/i-bonds-interest-rates/
https://www.macrotrends.net/2521/30-year-treasury-bond-rate-yield-chart