What are bonds? Low-risk investments are designed to protect savings from inflation

(NEXSTAR) – With inflation reaching near-record highs, Americans across the country are facing unprecedented financial challenges. Gasoline, food, rent, all cost significantly more than last year.

Inflation hedging can also be a bit tricky, especially after the fact. And the Fed’s recent decision to raise interest rates 0.75% won’t make it easier for the average American to invest or go into debt until inflation (hopefully) slows in the coming months.

There is, however, an option for investors hoping to protect their current savings against loss of value, and it is becoming increasingly popular.

Series I Savings Bonds, also known as I bonds, are a type of savings bond designed to keep pace with inflation. Bonds accrue interest based on two rates: a fixed rate that stays the same over the 30-year life of the bond, and an “inflation rate” determined every six months by the US Treasury. I Bonds purchased before October 2022 currently offer a rate of return of 9.62%, with interest compounded semi-annually.

“I bonds are getting a lot of attention,” Brian Therien, principal fixed income analyst at Edward Jones Investments, told Nexstar. “I’ve definitely been getting more questions about I bonds lately, because of the high interest rates.”

It is important to remember that these interest rates do not remain constant. They are based on the Consumer Price Index (CPI), and the US Treasury calculates and updates these variable inflation rates twice a year.

“This interest rate is not long-term,” says Therien, who explains that the interest rate on the I bonds was much lower in recent years, and will decline as inflation slows.

Still, I bonds are considered very low risk, largely because they can never lose value like treasury bills, corporate bonds, or even stocks. The trade-off, Therien says, is that I bonds won’t earn interest as income either — rather, the interest is added to the principal.

“They’re best suited for investors who don’t need the income from bonds,” says Therien.

There are also a few other caveats. Individuals can only buy up to $10,000 in electronic I bonds per year (and an additional $5,000 in paper if they buy with money from a federal income tax refund). Bondholders also cannot redeem the bonds for at least a year, and they will be penalized for cashing in before the first five years by having to forfeit the previous three months of accrued interest, according to the Treasury Department.

That said, I bonds offer many advantages to investors who can hold them for at least a year, or ideally at least five.

“Compared to other bonds, they have what we call very good credit quality,” says Therien. “They’re very high quality in that you can be sure you’ll get your capital back because they’re backed by the US government.”

I bonds are also exempt from national and local taxes. Investors only have to pay federal income taxes on the interest, and even that can be deferred until the bond is cashed or until it matures. Eligible taxpayers may also be able to exclude interest from taxable income if they use the funds to pay for higher education.

“Price stability would be another advantage,” adds Therien. “There aren’t many opportunities to own something that doesn’t really fluctuate in price. Every other treasury bond, stock, cryptocurrency you buy, the price will fluctuate, but… with I bonds, that value doesn’t change. Few investments can offer this.

Series I Savings Bonds can only be purchased directly through the US Treasury. Click here for more information.