I Bonds in a Portfolio

Rates

Although each individual has unique needs and goals, I Bonds almost certainly have a place in an investor’s portfolio. A new I Bond has seen rates anywhere from 2.19 % to 7.49% with an average of 4.88% as of November 2005. Bonds purchased when the fixed rate was 3.4% or higher have seen rates over 9% for several intervals since originally bought. Depending on the rate of the bond, the rate can range from slightly better than Certificates of Deposit or high rate Money Market accounts to nearly the same as the average of the stock market over the past 80 years. Combined with the excellent tax protection benefits and very low risk expectations of I Bonds, all investors should consider owning at least some I Bonds.

Asset Allocation is the single most important element in creating a portfolio for your needs. While most professionals agree bonds should make up part of your portfolio, the exact amount depends on many factors. A general good rule of thumb is to hold your age as a percentage in bonds in your overall portfolio. For example, a 25 year old would hold 25% bonds and 75% stocks and other investments while a 50 year old would have 50% bonds and 50% other products. Determining what portion of that percentage of bonds you own is devoted to I Bonds is a personal choice dependant on many factors. While most bonds move opposite to the movement of stocks, I Bonds correlate to the movement of inflation, meaning both traditional bonds and I Bonds can be held together to create a diversified bond portion of your overall portfolio.

Taxes

I bonds are a very tax efficient investment product because they are exempt from state and local taxes and do not pay dividends like bond funds. The federal tax can even be waived if the bond is redeemed to pay for education costs.

I bonds are tax deferred products by nature. This means that taxes are only incurred when the bond is redeemed. Individuals in a high tax bracket may want to reconsider redeeming bonds as the tax applies to both the interest component and fixed component of the I bond’s rate. If redeemed in a period of high inflation and in a high tax bracket, some investors may realize a negative return on investment when adjusted for inflation. But, because I bonds continue earning for 30 years, most investors can hold onto the bonds until they are in a lower tax bracket, and then redeem the bonds. The lower the tax bracket you are in when you redeem the bond, the higher the real return you will achieve.

Because I Bonds are tax deferred, they can safely be placed in the taxable portion of your portfolio. Unlike bond funds or company bonds that are tax inefficient, I bonds have little tax considerations and therefore can be excluded from space in your retirement accounts. By having I bonds outside retirement accounts, this allows for more room in those accounts for other, less efficient funds.

Next: Learn about buying I Bonds from the Treasury Dept. >>

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