Goodbye iBonds?

With higher-than-normal inflation over the last two years, you may have read about an interesting investment opportunity that keeps pace with inflation: the iBond. While it has a number of limitations, iBonds have been paying attractive rates recently as their yield is based on inflation data, plus a fixed interest rate.

A number of people have been asking recently “Should I buy more?” before the rates reset on May 1^st. While everyone’s individual circumstances are unique, as of right now it appears most people would be better off NOT purchasing more iBonds, despite the current 6.89% rate. This is because starting May 1^st, the projected inflation portion of the iBond will be around 3.38%. While the fixed rate portion (currently 0.4%) may increase a little in May, anyone who purchases iBonds before May 1^st will maintain the 0.4% fixed rate portion for the life of their bond.

When you combine these rates with the 3-month early withdrawal penalty for anyone who redeems them within the first 5 years, the net interest earned over the next 12 months is likely to only be about 4.4%.

And even if you remove the 3-month penalty from the calculation, you’re still only likely to earn about 5.3% over the next 12 months without any option to cash them in during that time frame for new money invested.

Two years ago, a 4.4% or 5.3% yield on a very stable investment may have sounded great. But times have changed, and with higher interest rates there are likely better alternatives for your excess cash without the $10k annual iBond purchase limit and lack of liquidity for the first 12 months.

So what are these iBond alternatives? There are plenty of options, including and not limited to:

• Online savings accounts
• No penalty CDs
• Traditional CDs
• Brokered CDs
• Money market mutual funds
• Online savings and money market accounts
• US Treasuries

Please note the rates discussed are the best I could find as of this writing (4/19/23). Better options may now be available.

No-penalty CDs

A no-penalty certificate of deposit (CD) is a great option for cash you don’t plan to use on a regular basis and want to have parked for emergencies or some other upcoming short-term goal. You can lock in a competitive interest rate for a fixed period of time (typically somewhere between 11 and 36 months, although it varies by bank) and unlike traditional CDs, there is no penalty for an early withdrawal.

Although you may earn a slightly lower interest rate than traditional CDs, it is really nice to not have to worry about any early withdrawal penalties should you need the funds sooner than expected. Because as we all know, life happens.

A strategy I like to use personally is to purchase multiple no-penalty CDs. That way if I happen to need to use my emergency fund at a time when interest rates have declined, I can cash out only one of the CDs and leave the remaining ones earning a higher rate.

Current best offer: 4.92% APY for 12 months

Traditional CDs

As mentioned above, traditional CDs usually offer slightly higher interest rates than their no-penalty cousins because your money is locked up for a specific time period, with a penalty if you need it sooner. Traditional CDs may require a minimum investment to obtain the advertised rate.

Best offer: 5.25% APY for 6 months

Brokered CDs

As an alternative to no-penalty and traditional CDs, there are also CDs available on the secondary market through traditional brokerage accounts. These can be purchased or sold through your brokerage company and the yield varies based on the maturity date. When using brokered CDs, be sure to watch out for any transaction fees to purchase or sell them. Also, know that they may lose value if interest rates rise and you need to sell them before the stated maturity date. So while they don’t have any early withdrawal penalties, they still have some interest-rate risk.

Current best offer: 5% APY for 12 months

Money Market Mutual Funds

Within brokerage accounts, there are usually options to purchase money market mutual funds. While the options vary widely based on the custodian and the amount of cash you are looking to invest, they can be an easy way to park cash temporarily.

When utilizing these funds, be careful of trading expenses and the underlying expense ratio for the fund, although just because a fund has a lower expense ratio doesn’t necessarily mean it will have the highest yield. These funds would not be eligible for FDIC insurance and could technically lose money, although it is very unlikely.

Current best offer: 4.76% APY with $3,000 minimum (or higher if you have over $1M)

US Treasuries

While US Treasuries are not the same as cash, short-term treasuries can act as a good substitute given their high quality. When purchasing treasuries, one thing to remember is that their value will fluctuate until they mature. If interest rates increase, the value of any treasuries you hold will temporarily decrease. And the opposite is also true. So if you end up needing access to your funds before the maturity date, be prepared to accept less than you originally paid if interest rates have risen.

One additional benefit treasuries have is that they’re not subject to state or local income taxes. Not a big deal if you live in Texas, but it could make a difference if you live in California and are already in a high income tax bracket.

Current rate: 5.07% APY for 6 months

Online Savings and Money Market Accounts

Online savings and money market accounts are pretty self-explanatory. While they mostly originated from banks that had no (or very little) brick-and-mortar presence, there are some smaller traditional banks that have increased interest rate offerings in order to get a share of the online banking market.

While these instruments used to have a limit of six withdrawals per month, during the pandemic this limit was lifted so the accounts offer more flexibility than they did in the past.

Current best offer: 5% APY

Parting Thoughts

When considering any of these options, one thing to consider is FDIC insurance. This provides federal protection against bank failure or theft up to $250,000 per account holder, per bank. For more information on how to increase your coverage, visit the FDIC’s FAQ page. iBonds and US Treasuries would not be eligible for FDIC insurance, but as long as the US government doesn’t default on its debt, you should still be fine. Money market mutual funds would also not be eligible.

For additional resources on where to find some of the best rates available, visit Doctor of Credit, Save Better, or your investment custodian.