The Downsides to the 7% Series—Inflation-Indexed Bonds Everyone is Talking About

As inflation continues to grow in the United States, many investors are turning to inflation-indexed bonds. They offer a relatively safe and steady investment gain when other markets are experiencing more dramatic ups and downs. The two primary U.S. inflation-indexed bonds are:

• Treasury Inflation Protected Securities (TIPs)
• Series I Savings Bonds

What Are Inflation-Indexed Bonds?

These bonds are issued by the government and corporate entities. They pay interest calculated based on a principal value. The investor will receive the principal value when the bond matures. The interest payment increases or decreases based on the official inflation rate (Consumer Price Index). These bonds are generally considered to be a safe protection against inflation.

The 7% Series

These inflation-indexed bonds are known in the investor market as the “7% Series” because the composite interest rate jumped significantly to 7.12% for the period between November 2021 and April 2022. The composite rate is updated every six months. Depending on when you invest in the bond and when it is scheduled to mature, you will receive the prevailing interest rate.

The 7.12% increase in November was almost double what it was the previous period (3.54% in May 2021). This is why so many people are talking about I Bonds and TIPs recently. The rate has only been above 3% twice since 2008, so it was exciting when the rate suddenly jumped over 7%. We will know in May if the rate will go up again or if it will come back down. Any investors buying these bonds now will be affected by the new rates established in May and November of 2022.

What Are the Drawbacks of Inflation-Indexed Bonds?

Inflation-indexed bonds seem like a very safe bet in an inflated economy—and maybe even a great investment while the composite rate is currently so high and could go even higher. There is some truth to this, especially for conservative investors. These bonds are worth considering as part of an overall diverse investment portfolio. As with any investment trend, however, you should never rush to put all your eggs in this one basket.

There are some downsides to the 7% Series of inflation-indexed bonds:

Money Locked Up—It takes a full year (12 months) for I bonds and TIPs to mature. That means your money is tied up until that time and usually much longer. Liquidity is always a concern with any bond investment, so keep this in mind when putting your money in an inflation-indexed bond.

Tax Limit—There is a $10,000 per tax ID limit on inflation-indexed bonds. This means you can only invest so much.

Investment Penalty—Any bond held for less than five years is subject to an investment penalty. Understand how payouts and withdrawals work with any bond in which you invest.

Not IRA Eligible—Inflation-indexed bonds cannot be held in your IRA, thus providing additional limitations and lack of tax-deferral advantages. A good IRA could provide similar returns with better tax benefits.

Before you invest your hard-earned money in inflation-protected TIPs or Series I Bonds, consult with your financial advisor. Diversify your portfolio and make the right decisions for short-term earnings and long-term growth. For all your investment management needs, contact Illumination Wealth today.