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Post: Mark Hulbert: The silver lining of surging inflation: I-bond yields should climb above 9%

CHAPEL HILL, N.C. –Want to lock in a greater-than-8% return with U.S. Treasurys over the next 12 months?

Of course you would, especially given the higher-than-expected inflation numbers reported this week, with the Consumer Price Index rising 8.5% over the last 12 months. Our absolute minimum goal with a U.S. Treasury is not to lose to inflation.

Yet even this modest goal seems impossibly out of reach. The one-year Treasury yield currently stands at just 1.9%.

A solution is I-Bonds, which are U.S. savings bonds whose yields are adjusted by the prevailing inflation rate. Specifically, their yield is adjusted twice a year—in May and November—according to the Consumer Price Index’s trailing 6-month change. Its current yield, set last November, was 7.1% (twice the CPI’s change from April to September last year).

Based on this week’s inflation report, this yield should be set at 9.6% on May 1 (twice the CPI’s change from October through March). The Treasury Department should announce the new rate in the next few weeks.

I’ve written about I-Bonds before, and I refer you to that column for several important details. You can’t purchase an unlimited quantity of these I-Bonds, for example, and you can’t purchase them in an IRA. But you are allowed to purchase $10,000 of such bonds each year ($20,000 per married couple) and an additional $5,000 per year with your tax refund. A strategy of buying the maximum amount each year over a long period results in a sizable fixed-income allocation—big enough to satisfy the asset allocation requirements of all but those with a very large net worth.

Zvi Bodie has done as much as anyone, if not more, to champion I-Bonds. Bodie, now retired, was for four decades a finance professor at Boston University. In an interview, he said that buying I-Bonds is a no-brainer, and he implores all of us to purchase as much as we can each and every year.

Buy now or in May?

The only real question is whether to buy an I-Bond now or wait until May. It’s tricky because your I-Bond’s inflation-adjustment factor will be reset every six months based on the initial month of your purchase. So if you purchase an I-Bond now, the interest you will earn over the next six months will be the rate the U.S. Treasury set last November—7.1%. And during the six-month period beginning this coming October, your rate will be equal to the rate the U.S. Treasury will establish in May—which I expect will be 9.6%. That averages out to 8.4%.

That’s not half bad, of course. Could you do better over the next 12 months by waiting until May to purchase? The answer depends on what the trailing 6-month inflation rate will be this fall when the Treasury establishes the new I-Bond interest rate. If it’s lower than 7.1%, then you would be better off buying an I-Bond this month. If it’s higher, then you should wait until May.

Your guess is as good as mine which of these two scenarios will play out. The markets this week are celebrating indications that inflation may have peaked with this latest report and is about to decline significantly. The S&P 500, for example, was up over 1% in the immediate trading following that report’s release.

Bodie suggests that if you don’t want to bet what inflation will be like this fall, you simply split your I-Bond purchase in two, buying half now and half in May.

It’s hard to go wrong even if you make the “wrong” choice, however. Even if you wait until May to buy an I-Bond and November’s reset rate is as low as 4%, you still will earn 6.8% over the 12 months from April 30 of this year to April 30 of next year. That’s far better than any alternative savings vehicle that guarantees the return of principal.

In any case, Harry Sit, author of The Finance Buff blog, reminds us that there is no need to focus on just the next 12 months. In an email, he pointed out that “I-Bonds are good for 30 years.” Unlike TIPS, furthermore, I-Bonds are structured so that their yield can never be negative.

Sit recommends that we buy I-Bonds this month rather than wait until May. He points out that you earn an entire month’s worth of interest even when you buy near the end of the month. So that yield of more than 8% that I mentioned at the start can really be thought of as even better, since it is for a holding period shorter than a year—as short as 11 months and one day.

Sit cautions, however, that since April 30 this year is a Saturday, you shouldn’t try to cut it too close. “The last day to issue the [I-Bond] for April is April 29. The order has to be in on April 28 at the latest. I would give a few more days of buffer just in case something goes wrong. If you don’t have an account set up already, sometimes they [the U.S. Treasury] require extra ID verification, which takes time to resolve. If you already have an account good to go, you can pre-schedule the purchase now for the 27th. If it fails somehow, you still have another chance on the 28th.”

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com.

Now read: Hedging against inflation: TIPS vs. I Bonds

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