Investors bruised by the stock market are crawling back to savings bonds — here’s what this once humble, now hot asset can do for you

Does looking at your portfolio these days make you feel a little queasy? Don’t bother consulting WebMD: It sounds like you might be suffering from stock market whiplash.

With inflation at a 40-year high of 8.6% and interest rates on a steep rise, investors are searching for safe havens.

Enter savings bonds. Since they carry little risk, you’d normally expect a modest return on investment. But when inflation and interest rates rise, they inch closer to average stock market returns, making them a tempting alternative in a bear market.

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Bonds are like a loan to the government

Essentially, a U.S. savings bond is a debt security issued by the U.S. Department of the Treasury — or in layman’s terms, it’s a loan to Uncle Sam. You can purchase them online through the U.S. Treasury Department's TreasuryDirect.gov website.

A savings bond earns interest until it “matures” at 30 years, and you can cash out penalty-free anytime after five.

When you redeem your savings bond, the government repays the amount you lent them, plus interest — similar to a certificate of deposit.

There are currently two types of U.S. savings bonds available for purchase — Series EE and Series I.

Series EE U.S. savings bonds are also known as "patriot bonds," and you purchase them at face value. That means if you want to buy a $50 EE savings bond, you pay $50 for it. The interest you earn on your Series EE bonds compounds semi-annually, adding to the face value of the bond. When you redeem EE savings bonds, you receive the full face value plus your interest on top.

Series EE bonds are currently offering a fixed interest rate of 0.10%. However, if you hold your EE bond for 20 years, the government will make a one-time adjustment to ensure it’s worth twice as much as you paid for it, regardless of your interest rate.

Series I U.S. savings bonds protect from inflation, which is what the "I" stands for. You purchase Series I bonds at their face value and earn semi-annually compounding interest for up to 30 years plus additional earnings based on the inflation rate. In a deflationary economy — like during the Great Recession — your earnings rate could potentially be lower than the fixed rate, but it will never dip below zero, so your initial investment is safe.

The interest rate on Series I bonds is made up of two components: one for the fixed rate that applies for the life of the bond and one for inflation, which is adjusted every six months. The current rate as of July 1 is 9.62% — that’s entirely based on the inflation component, as the fixed rate right now is 0%.

What makes them such a safe investment

Bonds in general serve as an effective portfolio diversification tool. Because they have a low correlation with other investment asset classes, when you add them to your portfolio, they can help buffer the shock of market crashes.

To help spread out your risk, financial advisers have traditionally recommended the 60/40 investing rule — 60% stocks and 40% bonds. While the 60/40 rule has lost traction in recent years of rock-bottom bond yields, with inflation on the rise, those low bond yields are making a turnaround.

Savings bonds are among the safest types of investments. To lose your money, the government itself would need to collapse. Since that’s unlikely to happen, your biggest risk would be earning zero interest on a Series I savings bond if inflation went negative.

In addition to diversifying your portfolio, savings bonds can also supplement your retirement savings. With Series EE bonds and I bonds, you can invest up to $10,000 in each type per year, which means heaps more tax-deferred savings beyond the contribution limits of your IRA or 401(k).

It's not all upside, though

That said, there is one big thing to consider with savings bonds — they are temporarily illiquid, meaning the money you invest isn’t immediately available if you need it.

You can’t touch your savings bond money for the first year. And if you redeem it before five years, you’ll sacrifice three months of earned interest. That means if you redeem a bond after 18 months, you’ll only earn 15 months’ worth of interest.

Savings bonds are more for stable, long-term savings than for unexpected emergencies. You should already have an emergency savings fund built up, ideally in a high-yield savings account.

When you have a lump sum of money that you’d like to invest for a longer period, savings bonds can help balance out the risks associated with the stock market. But due to the lower returns, it’s generally not a good idea to put all your eggs in the savings bond basket.

When it's time to cash in

To get the most from your savings bonds, hold them until they mature to benefit from compounding interest.

As of February 2022, the government reported that more than $26 billion is sitting dormant in unredeemed, matured savings bonds. If you might have money tied up in old savings bonds, you can search for it on TreasuryHunt.gov.

Don’t forget you’ll have to pay federal taxes on the interest you earn. You can choose to pay taxes on the interest you earn each year, or you can pay it all at once when you cash out, give up ownership or when the bond matures.

A loophole to avoid federal taxes on your interest income is to use it for higher education expenses for you, your spouse or your dependents. There are a few eligibility requirements, but if you qualify, it’s an easy way to boost your return on investment.

Hopefully that helps settle your stomach when you think about your portfolio these days. And if not, maybe it is time to see what WebMD says.

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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.