I bonds or TIPS ETF?
I’ve invested in both as an inflation hedge and, in this video, I’m gonna share with
you which one I prefer investing in myself right now and I’ll talk through my reasons
behind that choice.
Because everyone has their own unique situations and because economic times change, I’ll
go over the pros and cons of both TIPS and ibonds to help you best decide which option
may be the best investment choice for you, whether that's now or in the future.
And finally, I’ll also tell you what I’ll be looking at and planning to do once inflation
gets under control.
If you’re looking for a video on I bonds and TIPS compared, this video is for you.
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Okay, onto inflation, this word has been on the top of everyone’s minds, whether it’s
in the everyday world or the investing world.
In our everyday lives, we’re seeing everything costing a lot more…gas prices, groceries,
everything at the highest rates in 40 years.
And for investors, that inflation has led the Federal Reserve to start trying to tamp
it down by raising interest rates.
And when interest rates go up, stock prices tend to go down….and if you’re an investor
in the stock market, you’ve seen quite a hit to your portfolios…and I’m right there
with you.
So knowing all of this, you’ve been doing your research and trying to figure out how
best to invest in a period of high inflation, which is probably how you found this video.
And most likely in your research you keep coming across two popular options: series
I savings bonds, or just I bonds, and then also Treasury Inflation-Protected Securities,
more commonly referred to as TIPS.
Now in the past, I've made and released comprehensive videos on both types of investments which
were meant to give you a good understanding of what each of them are and how they work;
if you're still learning about TIPS and ibonds and haven’t seen those videos yet, I’ll
link them in the description for you…I would really recommend watching them if you are
seriously considering investing in either TIPS or I bonds.
Now this video is different, because today, I’m gonna compare and share my own personal
experiences with I bonds and TIPS by explaining the pros and cons of each, the reasons I invested
in them at the time I invested in them, and then finally tell you which one I prefer investing
in today and why.
So early last year, it was obvious to me that inflation was right around the corner after
everything was returning back to normal, yet the Fed was still not raising interest rates.
As someone that had never had to invest within a high inflation environment but was anticipating
that time coming, I started to look at my options and found I bonds and TIPS, probably
just like you.
Now I had never been a bond investor at the time so I began learning all I could on both
I bonds and TIPS and ultimately I made my decision to invest in TIPS.
The reason I invested in TIPS first was not because of the fundamental differences of
how TIPS and I bonds work, where TIPS keep a fixed interest rate with a principal that
is adjusted with the rate of inflation, whereas with I bonds, the actual rate itself is what
is adjusted…again, if you don’t understand this fundamental difference, definitely check
out the videos linked in the description as they will make this more clear for you.
Anyway, as I was saying, that difference in how they adjust to inflation was not the reason
I chose TIPS; I chose TIPS because of three other reasons, the first being the biggest
reason for me, which was convenience.
Unlike I bonds where you have to invest in them directly with the US Treasury, you can
invest in TIPS bonds through a TIPS ETF using any of your current investment brokers or
trading platforms.
Now you can also buy your own TIPS bonds directly through the US Treasury as well, but the convenience
of buying a fund of TIPS with my current investment account where I could easily buy and sell
shares, just like I do with any of my stock ETFs I’ve invested in, was very attractive
to me and the main reason I initially chose a TIPS ETF over I bonds or even standalone
TIPS.
The second reason that I went with a TIPS ETF was for liquidity, meaning you could literally
buy shares one day and then sell them the next day with no penalty.
Even if you bought your own TIPS bond directly through the Treasury, you could also sell
it before maturity on the secondary market without any penalty, but it’s just not as
easy as with an ETF.
Now with I bonds, it’s a whole different story.
First of all, there is no secondary market for I bonds, meaning you have to buy and sell
them directly through the US Treasury.
And once you buy them, you can’t cash them in for at least 12 months.
There’s just no way around it.
So if you were to need that money anytime within the next year, you'd be out of luck
because you won’t be able to access it until a full year has passed.
Because of this liquidity issue, an I Bond is not where you would want to put your emergency
funds or money you may need within the next 12 months.
Now after a year passes, you can sell it anytime afterwards, but another consideration is,
if you cash it in before holding it for less than 5 years, there is a penalty where you
would have to forfeit the last 3 months of interest.
Now after 5 years, that penalty goes away, but you can see how that’s quite a long
time where inflation could have subsided well before you would be able to sell the I bond
penalty free.
And then finally, the last reason I went with a TIPS ETF over an I bond was the annual limits.
With an I bond, you’re limited to buying up to $10,000 worth of I bonds for yourself;
that limit does not apply to TIPS ETFs.
Now if you’re married, your spouse could buy their own I bond and you could buy I bonds
for others as gifts, but for yourself, per person, per year, you’re limited to $10,000.
Now that’s not an insignificant amount of money, but if you’re someone that has a
fairly substantial amount of savings, this just means that I bonds won’t be able to
fully hedge your investing capital against inflation.
So let’s say you have an investment portfolio of $500,000, you could only utilize I bonds
to hedge 2% of your portfolio against inflation.
Now that doesn’t mean you can’t or shouldn’t consider I bonds, it’s just that if you
have a higher net worth, they would only serve as a small part of an inflation-hedging strategy.
Alright so at this point, you’re seeing the pros of a TIPS ETF over the cons of ibonds
and probably are understanding why I first went with a TIPS ETF.
But as I shared, I have bought an I bond as well.
So let me now explain how I came to investing in an I bond, which is where you’ll see
the big potential advantage of an I bond over a TIPS ETF.
So as I mentioned, I bought into a TIPS ETF early last year and have held it close to
a year and a half now where I’ve had 5 quarterly dividend payouts to me.
The dividends over this period of time have provided me an annualized return of 5.3%,
which isn’t bad, right?
Especially after seeing the big negative returns on the stock market year to date and remembering
that the inflation rate when I first bought into the TIPS ETF wasn’t as white hot as
it’s been the last few months.
But here’s the problem with a TIPS ETF and buying it now; being that it’s on the secondary
market, you’re buying shares of a fund that are constantly at the whim of traders who
are pricing in not only the underlying values of the TIPS the fund holds, but also how they
see inflation trending in the future.
So while we’ve seen high levels of inflation this spring into the summer, we also know
the Fed is actively, and aggressively hiking rates and we expect that to begin to lower
the rate of inflation in the near term.
Because of this, the value of each TIPS ETF share has since gone below the price I bought
it at because traders are always speculating or looking into the future.
When I do the math over the period of me owning the TIPS ETF with the dividends earned minus
the non-realized capital loss, I’m currently ahead by only about 1.5%.
That’s not great, but again, better than the stock market has been doing recently with
declines around 20% and still better than any basic savings or money market accounts.
Now in a minute, I’m going to tell you what I think will happen with my TIPS ETF in the
near term.
But first let’s get back to I bonds and what I consider to be the big advantage of
buying them, at least right now.
And that is, depending on when you buy an I bond, you can know, not speculate, but 100%
know your actual, guaranteed rate of return for at least the next 6 months.
And if you buy it in one of 2 specific months of any year, you can know your rate for the
next 12 months, which would completely cover the mandatory time you have to own the bond
before you’re eligible to redeem it; I’ll tell you that trick in a second, because that’s
what I did for myself.
For just a very quick background, the adjustable inflation rate component of an I bond is updated
every six months based on changes in the CPI, or Consumer Price Index.
This update to the inflation rate occurs two times per year: on the first business day
of May and on the first business day of November.
Again, my I Bond Explained video can give you more details on how this works, but for
the purpose of this video, what you need to know is that any I bond bought today through
the end of October 2022 will pay interest at 9.62% for 6 months from the month you bought
it.
As I said, you have to hold to at least 12 months, so let’s take the completely hypothetical,
worst-case scenario, where all of the Fed’s tightening works quickly and the inflation
rate drops to 0% or even if it goes negative where deflation occurs; even if that were
to happen, you still would have,,at minimum, a 4.81% return for the next 12 months, which
would still be better than any interest-bearing bank savings account and better than what
my TIPS ETF has done since I’ve owned it.
Although, just always keep in mind that comparing past performance to future performance is
not an apples to apples comparison…to that point, I bonds weren’t paying anywhere near
this rate last year when I first bought into the TIPS ETF.
Now for the trick, okay, maybe trick isn’t the right word, but a strategy to know what
your I bond’s interest rate will be for 12 months instead of just 6 months.
So in April and October, the months before the updated CPI adjustments take effect, the
updated CPI numbers are released by the Labor Department that will let you know what the
upcoming rate adjustments will be, and you don’t have to figure it out, those numbers
will be reported by any reputable news source.
So what this means is, if you buy the I bond in April or October, you will get the current
rate for 6 months, and then the new rate will take affect for the next 6 months after that,
allowing you to know your rate for an entire year.
This can be a little confusing to understand, so if you're unsure, you can check out my
I bonds video or go to Treasurydirect.gov for more details.
So anyway, here’s what I did: in April I saw the rate was jumping to 9.62% starting
in May and that definitely caught my attention.
As of April, the current rate was 7.12%.
So I bought the I bond in April knowing that I would get 7.12% for the next 6 months which
would then go up to the updated 9.62% for the following 6 months; that left me knowing
that I would be guaranteed a return of 8.54% for the entire 12 months I am required to
own the bond before I could sell it.
And that’s guaranteed.
Something a TIPS ETF can’t provide.
So what does all of this mean now and for the future?
First of all, for right now with the current rates being what they are, I strongly prefer
investing in an I bond over the TIPS ETF.
All of the positives that I shared for the TIPS ETF over the I bonds don’t overcome
the relatively high guaranteed rate of return of the I bonds at the currently set I bond
rates.
Looking ahead, here’s some thoughts to consider.
First of all, I don’t claim to be able to see the future, so take this for what it’s
worth, but what I see happening is the Federal Reserve’s moves will begin to reduce the
rate of inflation…there’s evidence it’s already starting to happen…therefore the
next CPI adjustment to the I bond rate is very likely to be lower.
We’ll see what it actually is in October.
Whether you buy an I Bond now or in October, you will still be guaranteed 6 months of 9.62%
before the new rate kicks in: the benefit of waiting until October is you’ll know
what the following 6 month rate will look like allowing you to know your 12 month return.
Of course, by waiting, that means your 12 month requirement of holding the I bond is
delayed until after you buy it.
The fact you can’t sell your money for that period of time is the big downside for I bonds,
and as I mentioned earlier, one of the reasons I opted against buying them at first.
Initially, one of my concerns was the penalty of redeeming the ibond before 5 years, however,
I’ve since come to the conclusion that once the I bonds earning rates start to drop as
inflation drops, I’ll consider selling the I bond after 3 months once a lower rate takes
effect, which would minimize the penalty for redeeming the ibond for holding it under 5
years.
And I don’t expect to hold the bond that long because I do think inflation will be
tamed to the point where I'll then want to take that money and invest it elsewhere.
But if I'm wrong and inflation rates remain high, I’ll just keep holding the i bond
and considering buying more up to the annual limits each year until inflation subsides.
As for the TIPS ETF, in the short term, I would probably predict that the dividends
in my TIPS ETF will continue to increase because the underlying TIPS bonds that the fund owns
will continue to be adjusted up due to the current high levels of inflation, but the
value of the ETF shares will most likely continue to decline as traders speculate future declines
in the rate of inflation due to the Fed’s tightening.
Ultimately the issue with a TIPS ETF is that you have to consider the speculative nature
of the holding and realize that it adds additional risk.
Looking back, I thought I was ahead of the game by investing in the tips etf when I did,
but really I needed to invest a little earlier than I did…lesson learned.
So when I consider all of these factors for myself, the I bond is where I would invest
today.
But timing is important when you consider buying either an I bond or a tips etf.
Down the road, as economic times change in the future, I’ll look to buy TIPS ETF shares
when I think inflation will be coming, not when it’s already here.
And on the flip side, I’ll only buy I bonds once the inflation is already happening and
the higher rate is set.
So that’s what I’ve done and my thoughts on these two popular inflation hedges…how
about you, what do you think?
Today, are you buying into a TIPS ETF or are you buying I bonds?
Let us know in the comments.
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Until next time, thank you for watching…and have a great day!