What are I Bonds and Why I’m Buying
First of all, I must confess that I’m not a big fan of bonds in general. I have always been a stock investor and I didn’t understand why I needed bonds. Historically, the stock market has a higher return on investment (ROI) than bonds over the long term. So I thought, if I’m not concerned about volatility, then why not just invest 100% in the stock market?
*Originally written in 2013. Updated 2022.
100% invested in the stock market
I think going all-in on the stock market is fine if most of these apply to you:
In my 20’s, I fit the bill perfectly, but that’s no longer the case. I don’t make much money anymore so I won’t be able to add much during a down market. At this point, I’m not willing to lose 50% of my investment portfolio. 
Everyone needs some bonds
Over the last few years, I have been reading more financial books and all of them recommend holding some bonds. The Millionaire Teacher by Andrew Hallam showed me how holding bonds could be helpful during a down market. Bond prices usually rise during a bear market and you can sell some bonds to buy stocks at bargain prices. After I rolled over my 401(k), only 10% of my portfolio was in bonds and I have been working to correct that. Currently, I have 20% in bonds and 20% in cash. My target is to increase my bond holdings to around 30% in the next few years. Hallam recommends the same % of bonds as your age, but I will take my age minus 10 because I still want to be a bit more aggressive.
*2022 Update – My current bond/cash allocation is back to about 10%. I moved some money into the stock market when it was dropping. If the stock market continues to drop, I’m willing to go down to 5% bonds. Now that I’m older, I don’t agree with using age to set the % of asset allocation. It should mostly depend on your investing timeline and risk tolerance.
What Bonds to buy?
The interest rate is very low now and it will go up at some point. When the interest rate rises, bond yields will rise and bond prices will drop. From what I read, this is not a good time to buy bonds. One way to avoid price fluctuation is to buy bonds directly from the issuers and hold them until maturity. That way, you won’t be affected by the price fluctuation.
Series I Savings Bonds (I Bonds)
I Bonds are issued by the US Treasury and are backed by the US government. This is one of the safest ways to invest your money. A US resident with a social security number can buy up to $10,000 worth of I Bonds each calendar year.
Interest rate – I Bonds are indexed to inflation so the money you invest today will maintain its purchase power. The interest rate is a combination of two rates.
The good thing about I Bonds is the variable-rate will never be negative. Even if we enter a long period of deflation, the rate can drop to 0% at the most.
Tax advantages Tax Deferral – I Bond interest accrues in your account over the time you hold it. You only pay tax when you redeem your bond.
Tax Exemption – You don’t have to pay state and local income tax on the interest earned. One good way to take advantage of the tax deferral is to build a bond ladder. You can buy $10,000 of I Bonds per year and redeem them after you retire. You’ll most likely be in a lower tax bracket then and pay less tax. This $10,000 can be a nice supplement to your social security income. I Bonds interest is also tax exempted if you use it to pay for education. Your MAGI (modified adjusted gross income) needs to below a certain threshold though.
Limitations – You have to hold I Bonds for at least one year. If you redeem before 5 years, then you give up the last 3 months of interest. After 5 years, you can redeem the bonds without any penalty. Geez, that’s a lot of info. I tried to go over the most interesting points. You can read more about I Bonds and purchase them at Treasury Direct. 
Why I’m buying
I’ll assume most young folks don’t have a lot of bonds because they don’t know much about them. However, it is a good idea to have a portion of your portfolio in a safe and stable investment. The next time we have a bear market, I will be able to use these reserve funds to pick up some bargains. Let’s summarize why I’m buying I Bonds.
The initial interest rate on new I bonds is 9.62% through October 2022! That is huge. We purchased $10,000 each late last year and just picked up $10,000 each last month. The stock market isn’t doing well this year so I’m very happy to stash $40,000 in I bonds. I’ll sell off some of my bond funds to buy some stocks, though. It’s a good time to shop around if you have some money left in the war chest. Keep investing!
What about you? Do you have I Bonds in your investment portfolio? Why not open an account at Treasury Direct and buy some? You only need $25 to get started.
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