October 10, 2022: 9.62% Treasury I Bonds: Cash Is Indeed King

Oct 11, 2022 | Feature, Newsletter

Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

Regular AAC (Asset Allocation Composite), SAA and TAA portfolios are always rebalanced on the first trading day of a month. the next re-balance will be on Tuesday November 1, 2022. 

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

9.62% Treasury I Bonds: Cash Is Indeed King

We said ‘Cash Is King’ several months ago. In this newsletter, we explain a popular ultra safe US Treasury savings bond: ‘Series’ I savings Bonds or just I Bonds. If you buy this bond by the end of this month, you’ll get 9.62% interest rate for the next 6 months! This certainly can help investors to navigate through this rough period when everything (stocks and bonds) is in a ‘free’ fall.

I Bonds details

Here are some important details investors need to know about I Bonds:

  • I Bonds are officially called Series I savings bonds. They are part of US Treasury Savings Bonds (the other one is EE Bonds)
  • I Bonds are designed to allow investors to beat inflation by giving interests that are higher than inflation rates
  • I Bonds interest is reset every 6 months. Currently, for people who purchase I Bonds since May 1, 2022 to October 30, 2022, the interest is 9.62%!
  • I Bonds are mature in 30 years. So if you buy I Bonds today, you’ll get your principal and interests earned (compounded) 30 years later.
  • However, it does allow you to redeem (cash in) your I bond after 12 months. If you redeem it in less than 5 years, you’ll lose the last 3 months of interest. So you can’t get your money back if you need it within 12 months after purchase.
  • Unfortunately, it also has a serious limit on how much you can buy: up $10,000 every year. if you have tax refund, you can also buy another $5,000 each year.

The last one makes I bonds only be marginally useful for many people. Nevertheless, they do make a great gift to your family members.

How to determine I Bonds interest

The I Bonds interest is reset by the Treasury on May 1 and November 1 every year for the following 6 months. For example, if you buy I Bonds in December, your interest rate will be decided by the one calculated on November 1. 

The interest formula is as follows:

I Bonds Interest Rate = (fixed-rate + 2*semiannual-inflation-rate) +fixed-rate*semiannual-inflation-rate

The fixed rate is decided by the Treasury every May 1 and November 1. Little is known on how it’s determined. Currently, any way, fixed rate=0%.

The semiannual inflation rate is decided by CPI-U (Consumer Price Index for All Urban Consumers). You can find its historical (and latest) numbers here:

The May 1 semiannual inflation rate would be calculated as

(March2022-September2021)/September2021 = (287.504-274.310)/274.310=0.0480988.

So 0+2*0.0480988=9.62%

Note On May 1, we only know March’s inflation number, that’s why the March number is used. Similarly, On November 1, you only know September’s inflation number, that’s why the November semiannual rate would be calculated as

(September2022-March2022)/March2022

Note, currently we still don’t know what the September 2022 CPI-U number is. But given the current trend, it’s very likely it’s be flat from its August number or at most slightly higher. So we actually can estimate the November semiannual rate might be (296.171-287.504)/287.504=0.3014566 or the I Bonds rate will be around 0+2*0.3014566=6.03%!

In a word, if you want to get I Bonds, you better hurry up to buy it by the end of this Month to be able to lock in 9.62% interest rate for the next six months. Otherwise, it’s very likely to drop down to 6% or so.

TreasuryDirect.gov

How to buy I bonds? Unlike Treasury Bills that you can also get from brokerages like Fidelity, ETrade, TD Ameritrade etc., you can’t buy I bonds from your broker. You’ll need to go to TreasuryDirect.gov to do that. 

  • You’ll need to first open an account on TreasuryDirect by entering your ID info (social security number and driver license).
  • You then link it with a bank account.
  • Finally you need to ACH (electronic transfer) your money to the TreasuryDirect account
  • Then you can purchase I Bonds.

Notice that the TreasuryDirect account can be used to purchase other Treasury bonds such as Treasury Bills and EE Bonds.

In future newsletters, we’ll discuss in more details on how to purchase Treasury bills (and sell them if needed) in a brokerage account. Doing so will enable you to completely avoid expense charged by money market funds or banks. Remember, currently, you can get a Treasury Bill that’s mature in 3 months with interest rate as high as 3.4% or 4.2% of 12 months (see this Vanguard’s rate, for example)! 

Market overview

As we mentioned in previous newsletters, the current market weakness probably still has 1/2 to 2/3 to go. Bond yields are likely to continue their rise, at least by the year end. Stocks, on the other hand, might need another 15%-20% drop to make them on par with bonds. We remind our readers of some magic numbers of S&P 500: 3000 is on par with bonds, 2000 is becoming competitive and 1600 is an attractive level where investors should start to buy hand over fist. 

As an education, we recommend our readers to watch the recent interview of two portfolio managers (CALSTR or California State Teachers’ Retirement System and PIMCO) by Bloomberg to get some sense on what institutional investors think currently. To quote PIMCO’s Erin Browne in the interview, current consensus of S&P 500 earnings estimate is probably at least 15% too high (more likely 20% to 30%). Indeed, there will be more room for stocks to fall if the current trend continues. 

Currently S&P 500 is 3612. 

Of course, the above levels are based on historical valuation metrics. As always, we stay the course with our strategies and reiterate the following:

  • For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as what we have emphasized numerous times, when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years or preferably much longer given the current high valuation. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later and preferably many more years later) will deliver some reasonable returns. As long as you are comfortable with this thesis, you should sit tight and forget about the current gyration.
  • For tactical investors, again, you have to ignore the current market noise. Furthermore, you should follow your strategy rigorously, especially in a time like this. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This has been shown to be true time and time again.

Stock valuation has dropped and now valuation is becoming less hostile. However, it is still relatively high by historical standard. For the moment, we believe it’s prudent to be extra cautious. However how serious a correction might be, we have confidence in the US economy in the long term and thus in the stocks in aggregate. We just need to manage through interim losses carefully.

We again would like to emphasize that for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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