Earning a Risk Free 7% Return
A small consolation in a zero percent world
Inflation can be a self-perpetuating affliction. If consumers come to expect that the dollars in their bank account will purchase materially less in the coming months and years, there will be a natural inclination to trade depreciating currency for material goods and services in the near term. This is just one of many attributes of inflationary psychology that can result in rising prices, and not just for consumer goods. Asset prices can also inflate rapidly as consumers and businesses rush to invest or speculate in assets that might be resilient to inflation.
The uptick of inflation in recent months has captured the attention of the news media and it is now a rare day when we do not see articles in the Wall Street Journal and elsewhere describing inflationary pressures. Whether the inflation is “transitory”, as the Federal Reserve claims, or will prove to be more persistent is a debate that I will not enter at this point other than to say that in the here-and-now, inflation seems very evident in day-to-day transactions, not to mention levitating prices for real estate and financial assets of the most speculative variety.
If consumers felt that they have access to some viable and safe means of protecting their hard-earned money from inflation, they might be less inclined to spend the money or to “invest” it in the latest cryptocurrency craze. Unfortunately, savings accounts yield next to nothing and the treasury yield curve continues to offer microscopic yields, with next to nothing on offer for short term treasuries that act as cash substitutes.
For reasons that I do not fully understand, personal finance articles on savings alternatives routinely either ignore or gloss over the option of United States Savings Bonds. As I wrote late last year, there is a solid case to be made for consumers to take full advantage of these instruments as cash substitutes. Readers unfamiliar with how savings bonds work can find more information in that article, linked above, so I will not repeat the basics here.
On November 1, the Treasury announced that new Series I savings bonds will offer a composite yield of 7.12% for the next six months. This yield is comprised of a 0% real rate combined with a 7.12% inflation adjustment. Understanding how the composite yield is calculated is relatively straightforward. Every six months, the Treasury sets the real rate, which has been 0% for some time. In addition, the semi-annual inflation rate, as measured by the CPI-U index, is multiplied by two and added to the real rate. Since the semi-annual increase in the CPI-U was 3.56%, the composite rate is double of that at 7.12%.
So, for new I Series Bonds purchased today, the yield will be 7.12% for the next six months. After that, the yield will depend on the increase of the CPI-U over the prior six months multiplied by two.
There are a few caveats regarding using savings bonds to park cash. One cannot redeem these bonds for any reason for the first year. Additionally, any bond redeemed before the first five years will incur a three-month interest penalty. Finally, one cannot purchase more than $10,000 of these bonds in any given calendar year.
Despite these limitations, I think that I Series bonds represent a cash alternative that is too good to ignore. At a time when the one-year treasury bill yields 0.15%, the I Series bond is a no-brainer even if one cashes it in after a year and takes the three month interest penalty. Additionally, the $10,000 purchase limit applies to one individual. A family of four could purchase $40,000 of these bonds every year. And since it is late in the year, such a family could purchase $40,000 of the bonds in 2021 and another $40,000 in early 2022. It is also possible to purchase an additional $5,000 using the proceeds of a tax refund. The cherry on top is that savings bonds are free of state income tax liability and the federal income tax liability is deferred until you cash in the bonds.
I have never made specific investment recommendations in over twelve years of writing about investments, and this post isn’t advice either. But I would be remiss to not mention the possibility of earning a risk-free return that is multiples of what is offered through savings accounts and treasury bills.
Small investors who want to go out and binge on consumer products this holiday season or gamble on the latest crypto craze are, of course, free to do so. But no one can say that there is no viable risk-free investment that can protect at least some purchasing power for the vast majority of American savers.
Autumn Scenery
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No one talks about them because no one (Wall Street, your financial advisor) makes a buck off them. You have to buy them directly from the Treasury. Adverse incentives at work anyone? Nice post!