I-Bonds: A Unique Investment Worthy of Consideration

The legendary investor Benjamin Graham once sat for an interview in 1955. The interview was later published in the June 3, 1955 U.S. News and World Report. During the discussion, the interviewer pressed Graham on the different investment options a “small man” should include in his portfolio. Graham suggested a simple investing approach for such a person: carry necessary insurance and then invest in government bonds and the common stock of companies. The interviewer followed up, “When you speak of government bonds, you mean savings bonds?” Graham replied, “Oh, yes, I see no reason whatever for the small man to invest in government securities other than the very attractive savings bonds which he now can buy.”¹

The investing world has changed dramatically since Graham’s day. The investment products available to modern-day investors are more numerous than what those living in 1955 could access. The savings bond offerings have also evolved over the years. The program began with ‘Series A’ in 1935 and has slowly changed, introducing ‘Series I’ in 1998.

Understanding I-Bonds: The Pros and Cons

Today, Americans have two savings bond programs to choose from – ‘Series EE’ and ‘Series I.’ The ‘Series EE’ bonds offer a fixed rate, yield a lower-than-market rate, and double in value if held for 20 years. The doubling results in an effective nominal yield of 3.5%. Although a few applications for EE bonds exist, ‘Series I’ bonds (I-bonds) have more general utility. I can only speculate, but I imagine Benjamin Graham would be a proponent of I-bonds if he were alive today. Let’s take a look at the pros and cons of I-bonds to see why.

Pros:

1. Tax-deferral for up to 30 years or until they are redeemed.
2. The interest earned from the bond compounds automatically.
3. Inflation is guaranteed to be matched and is often exceeded.
4. There is limited risk from inflation, interest rate fluctuations, or deflation.
5. Low default risk.
6. Fully liquid after one year.
7. Exempt from state and local tax when redeemed.

Cons:

1. Cannot redeem for one year.
2. Three-month interest penalty if redeemed before five years.
3. $10,000 per person purchase limit per year.
4. Cannot be held in a tax-advantaged account (i.e. – 401k, 457b, Roth IRA, etc.).
5. Must use the Treasury Direct website.

The pros seem to outweigh the cons for anyone operating a long-term investing plan. In my last blog post on Invest Quietly (Invest, You Must: Protect Your Wealth Against Inflation) I mentioned how inflation is likely your number one opponent as an investor. I-bonds allow for an investor to take a safe and relatively-liquid position that will not lose purchasing power to inflation. In some cases, I-bonds can potentially gain purchasing power if its fixed rate component is positive. Let’s look at how an I-bond is constructed.

The Structure of an I-Bond: Fixed and Variable Rates

I-bonds have two components: variable and fixed. The variable component tracks the consumer price index for all urban consumers (CPI-U) provided by the Bureau of Labor Statistics. Therefore, the variable portion of an I-bond tracks a widely-used measure of inflation in the United States (US). The fixed component is set every six months and remains static after you purchase the bond. The Treasury of the US determines the fixed rate, and market conditions provide the inputs for the calculation. The rate will trend higher when marketable real rates (Rates of Treasury Inflation-Protected Securities) have increased. The fixed portion is what determines the rate you earn over inflation. This amount is known as the real rate of return.

I-Bonds vs. Marketable Bonds: A Comparison

The most unique element of an I-bond is its immunity to interest rate fluctuations while also hedging inflation. These are strong and important advantages. The best way to demonstrate the uniqueness of an I-bond is to compare it with other prominent and widely-used bond investments.

In July of 2005, an investor could purchase an I-bond with the exact same fixed rate as those being offered in February of 2025 – 1.20%. Moreover, the bond market was very similar in 2005 to the environment today with 10-year treasuries yielding over 4% nominal and 10-year TIPS yielding approximately 2% real. In Figure 1 below, I compare the performance of an I-bond purchased in July of 2005 against the commonly-held submarkets of US total intermediate nominal bonds, US intermediate Treasury Inflation-Protected Securities (TIPS), and US short-term treasuries. The funds I use as proxies are VBMFX (Vanguard Total Bond Market Index Fund), VIPSX (Vanguard Inflation-Protected Securities Fund), and VFISX (Vanguard Short-Term Treasury Fund) respectively. In Figure 1, you can see how one dollar grew in nominal terms for each investment between July of 2005 and December of 2024.

In Figure 2 below, you can see how the same one-dollar investment performed on a real return basis.

The nominal and real rates of return for the time period are in Table 1 below.

Explanation of I-Bond Outperformance in Recent Years

As you can see, the I-bonds outperformed the other three bond market funds rather handily between July of 2005 and December of 2024. Why did this happen? VBMFX and VIPSX were outperforming I-bonds for most of the period. However, at the end of the day, the explanation is quite simple. The two largest risks for marketable bonds (inflation and interest rate risk) made an appearance between 2021 and 2023. An I-bond is not heavily affected by either risk, which explains why it surpassed marketable bonds during this period.

You may have noticed something interesting above regarding the real return of I-bonds for the period. I-bonds had a real return of 1.39% even though the fixed portion for an I-bond issued in July of 2005 is 1.20%. There are two explanations for this:

• #1 – There were two six-month periods of deflation between July of 2005 and December of 2024. Specifically, the short-lived deflation of 2008 is what drove the change for this particular I-bond. During times of deflation, I-bonds cannot earn less than 0% nominal even if the inflation component (variable rate) goes negative. This can provide an extra boost over inflation.

• #2 – The variable rate of an I-bond and the actual incurred inflation for a set period do not perfectly line up. An I-bond’s variable rate has a sixth-month lag. This can lead to a bit of movement around what an I-bond’s stated fixed rate is and the actual results at any given moment in time. This lag is reflected in the movement of the I-bond line in Figure 2.

I-Bonds and Low-Rate Environments

Due to the massive bond bear market of the last few years, nearly every I-bond purchased since the inception of the program is now outperforming the three segments of the bond market referenced above. That includes I-bonds with a fixed rate of 0%. Those I-bonds only earn the inflation rate. An example of this can be seen in nominal terms in Figure 3 below. The comparison is against the same three funds above with the addition of STIP (iShares Short-Term TIPS fund). This fund was created in 2010, and, for our purposes, serves as a proxy for the short-term TIPS’ submarket. The chart shows the nominal growth of one dollar in the time period from January 2012 to December 2024.

In Figure 4 below, you can see how the same one-dollar investment performed on a real return basis.

Figure 4 shows how the zero interest rate policies (ZIRP) of the 2010s followed by the inflation in the 2020s led to a dismal environment for bonds. Most bonds bought in the 2010s have lost wealth to inflation. The nominal and real rates of return for the time period are in Table 2 below.

Final Thoughts: The Value of I-Bonds for Long-Term Investors

At the end of the day, I-bonds can be a steady force in a portfolio. They earn their fixed rate above inflation no matter what is going on in the world. For this reason, they make for an excellent pairing in a stock-heavy portfolio. If stock prices decline for any reason, I-bonds will maintain their value along with their steady growth rate as long as the US government continues to exist and remain solvent. Marketable bonds, on the other hand, cannot make this claim. There are years, like 2022, where stocks and marketable bonds fall together. I-bonds provide rebalancing options in every market environment.

I often hear the argument that I-bonds have a restrictive contribution limit. While restrictive for some people, $10,000 a year is still a lot of money for most people. There are many who struggle to save that much in total every year, let alone for just a portion of their portfolio. I-bonds can be a very valuable investment tool for middle-class Americans.

I-bonds offer a solid fixed-income option for long-term investors. Most importantly, they are unique. You cannot invest in anything exactly like them on the open market. Like all investments, they have their pros and cons and might not suit everyone. However, don’t be too quick to dismiss them. Do your research and see if they might have a place in your portfolio.

Thanks for reading.

¹ Interview with Benjamin Graham Expert on Investments: How to Handle Your Money. (1955). U.S. News & World Report, 42–48.

Data source for:
Funds: Yahoo Finance
CPI-U: Bureau of Labor Statistics
EE and I-bonds: Treasury Direct & eWorkpaper

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