In a prior article, we discussed the importance of maintaining an emergency fund. We offered our insight into how much is appropriate to keep in cash or savings, as well as emergency fund targets. As a result of that article, we were asked the question: “Where can I invest my emergency fund, such that it earns an interest rate that is higher than 0%?”
Our normal response to this question is a credit union or online bank where interest rates tend to be higher than commercial banks. However, for some people, an investment into I Bonds (a type of savings bond) may be ideal.
To be clear, I Bonds are not a replacement for readily available cash. In fact, money invested in I Bonds cannot be touched for a 12 month period. But for those investors, who know they will not need access to a certain portion of their emergency savings for at least 12 months, I Bonds may be a great alternative to cash or money market.
The following is a summary of key characteristics of I Bonds:
- The “I” in I Savings Bonds stands for inflation. This is because a component of the interest earned on I Bonds is based on the inflation rate.
- I Bonds are guaranteed by the “full faith and credit” of the U.S. Government.
- Each taxpayer is allowed to invest up to $10,000 annually in I Bonds.
- I Bonds are purchased at face value at a variety of dollar denominations ($100, $250, $500, etc.) and have 30 year maturities.
- I Bonds can never lose value and the redemption value can never decline. As such, this feature also protects I Bond investors from deflation.
- Returns on I Bonds consist of a fixed rate component and an inflation component. The fixed rate component (currently 0%) remains the same for the life of the bond, while the inflation component adjusts every 6 months (in November and May).
- The current interest rate on I Bonds issued until May 2012 is 3.06%.
- Interest earned on I Bonds is tax-deferred until redemption or final maturity.
- I Bonds redeemed within the first five years of purchase result in the forfeiture of three months of interest.
- I Bonds cannot be held or purchased in brokerage accounts.
Like all investments, I Bonds may not be for everyone. However, we believe they are a great alternative for those seeking a low risk investment that offers an element of inflation protection. To find out more information or to purchase I Bonds, you can visit www.treasurydirect.gov.