Series I Bond Arbitrage

Note: The following is a whole bunch of words with very little financial payoff in the end. But, if you’re into stuff like this, it still might be mildly interesting.

Series I Savings Bonds became very popular a couple of years ago with the surge in inflation, and many folks moved some money into I Bonds in order to take advantage of those great interest rates. Now that inflation has calmed down the I Bond rate has gone down. As of May 1st the interest rate reset to 4.3%, of which 0.9% is the fixed rate and 3.4% is the inflation rate (meaning for many existing I bonds that have a 0% fixed rate they are now only earning 3.4%). Many of those same people are now asking if they should move their money out of I Bonds. My response to that has been that it depends on what the purpose is of the money you have in I Bonds. If the purpose was to get the highest interest rate available at the time then, yes, you may want to move your money out of I Bonds soon as they’ll be getting “only” 3.4% in your next 6-month period and you can get higher than that in a high yield savings account (currently 3.75% at Ally), a Money Market account at a brokerage (current yield on the Vanguard Federal Money Market Fund is 4.77%), or in T-Bills (currently 5.08% on a 6-month T-Bill).

If, however, the purpose for the money in I Bonds was simply your “emergency savings” (which I just refer to as “savings”), and your goal is for that to simply keep up with inflation, then you can just leave it there. It will continue to more-or-less match the rate of inflation no matter what inflation does (and will never go below 0%), and that’s really what you want/need your savings to do. Really the only thing to pay attention to is when thirty years are up for any individual I Bond purchase, as at that point your I Bond will stop earning interest.

For those who do decide to move their money out of I Bonds, a reminder that you can’t do that until you’ve held them for 12 months and, if you redeem them before 5 years are up, you will lose the last 3 months of interest. (And when you redeem your interest then becomes taxable on your federal return.) What many folks will want to do is calculate when their existing I Bond will drop to this new 3.4% rate, add 3 months, and then redeem then. That way they will lose 3 months of 3.4% interest instead of 3 months of the currently much higher rate (6.48% for many folks who first purchased when I Bonds become popular). For example, the first Series I Bond I purchased in my name has an issue date of 12-01-2021, which means it will keep the 6.48% interest rate until June 1st, 2023, then reset to the new 3.4%. So if I were going to redeem that one, it would probably make sense to wait until September 1st so that the 3 months of interest I lose are at 3.4%. I have a second I Bond in my name with an issue date of 2-01-2022, so that one will continue to receive the 6.48% rate until August 1st, so I would likely wait until November 1st to redeem.

For those folks who are using Series I Bonds as their savings and simply want them to keep up with inflation, there is a possible arbitrage-like opportunity right now. The fixed rate portion of I Bond yield has been 0% or close to 0% for most of the last decade plus, including for the time period when most people reading this likely purchased their I Bonds (Fall of 2021 and/or Spring of 2022). But the fixed rate for new I Bonds beginning May 1st is 0.9%. Now, that may not sound like much (and it isn’t), but what that means is any I Bonds purchased in the next six months will earn 0.9% above the current rate of inflation for the next 30 years (in other words, savings that is guaranteed to beat inflation).

This is where the arbitrage-like opportunity arises. Let’s take the first Series I Bond I mentioned before, where I might consider redeeming it on September 1st, losing three months of interest at 3.4% (which equates to losing 0.85% interest). I could then turn around and immediately buy a new I Bond, which would then be earning 4.3% and, crucially, 0.9% higher than the current rate of inflation for the duration of the bond. That means that in less than a year I would’ve “made up” the 0.85% interest that I “lost” and then for the remainder of the term of that I Bond (up to 30 years) I would be earning 0.9% higher interest than I would’ve if I’d simply held the original bond (and, of course, there’s some compounding in there that makes it even better). Of course it’s possible that the fixed rate come November 1st will be even higher than 0.9% but, historically, that hasn’t happened since 2007 so it’s not terribly likely. (And, if the fixed rate does continue to go up, you can do this all over again once your year is up).

None of this is going to make you independently wealthy. But if you’re reaching for yield, then perhaps cash in and move to a Money Market account at a brokerage or a T-Bill. Or if you are truly using this as your savings, consider locking in that additional 0.9% for 30 years (with a reminder that it’s not accessible at all for the first 12 months).

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