Things are looking good for interest rates on a fixed income. The Federal Reserve is raising rates to combat inflation, which makes savers very happy.
Don’t get too excited because increasing interest rates will indeed crash the economy. High mortgage rates will slow the housing market, which may cause a full-blown recession.
Now, more than ever, we need to be very selective in our investments. Dividend yields are up because stock prices are down. However, we must diversify between stocks and bonds to protect our capital from the unknown.
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Enter Treasuries. With Federal Reserve rates moving higher, this pumps up the rates on Treasuries. I recently wrote that I am a buyer of 30-Year Treasury Bonds over 4%.
But let’s not forget our Series “I” bonds. They have been yielding over 9% for close to a year, with no sign of slowing down.
Let’s say I have $500/month to invest in Treasuries; how would I allocate that amount between Series “I” and 30-Year Bonds? More importantly, why would I invest this way? Let’s begin.
What are the differences? Right off the bat, let’s look at the differences between the two products. Both types of bonds have rising interest rates currently, but for two entirely different reasons.
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Series “I” Bonds move alongside inflation numbers. This means that when inflation is high, interest on Series “I” Bonds is high.
30-Year Treasury Bonds move along with interest rates the Federal Reserve sets. The Federal Reserve sets its target interest rates, and the US government sets its rates on its various treasury products (2-year, 10-year, 20-year, 30-year, etc.).
It’s important to note that the bond market adjusts the prices of Treasuries. Therefore, if the US Government sets the 30-Year at an interest of 4%, the bond market can bid it up or down. The bond market is forward-looking and adjusts based on its views of the economy.
How do these bonds pay you? Another major difference is how the bonds pay you. Series “I” Bonds are outstanding for compounding interest because the payments stay inside the bond.
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You do not receive any payments from Series “I” Bonds over the years. They will grow and compound like their own separate savings accounts. This is good for tax purposes, as you’ll pay taxes when your bonds mature in 30 years.
30-Year Treasuries pay interest semi-annually, and the government will tax you at your standard tax rate. However, Treasuries are exempt from state tax, which makes them great investments in high state tax areas like California and New York.
30-Year bonds pay you instead of compounding, but that doesn’t mean they don’t earn compound interest. Bond reinvestments are an essential part of bond investing.
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“The Bond Book,” says bond investors aim to reinvest bond interest at a similar or higher rate than the bond coupon.
Therefore, if you have a 30-Year earning of 5%, you would aim to reinvest the interest payments at 5%. You can buy more bonds or use them to buy different products like USDC or dividend stocks.
This brings up a great question. What would happen if you reinvested your bond interest into high-yield dividends or USDC? How would your investments differ over time versus a Series “I” Bond?
High-Yield Reinvestment. The main benefit of receiving your interest payments over the 30 years would be diversified reinvestment.
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Let’s say you put $10,000 into a Series “I” Bond for 30 years, with an average of 5% interest. You would have roughly $44,000.
If you bought a $10,000 30-Year Bond at 5% and reinvested at 9%, you would have much more cash. Honestly, I need to find a good Bond Reinvestment calculator to get the math right. I’ll do a deep dive on bond reinvestment in a separate article.
How I would allocate $500. Currently, the 30-Year Bond is sitting at 3.374%. I am not a buyer at these prices.
I would allocate all of the $500 to Series “I” Bonds. Remember, there is a $10,000 annual limit per individual.
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However, as yields on the 30-Year increase, I would buy more. At 4%, I would divide my $500 in half—50% to 30-Year Bonds and 50% to Series “I” Bonds.
When 30-Year rates hit 5%, I will put $400 into them monthly. Once they get over 6%, I am 100% in 30-year Treasuries.
What is the future of inflation and interest rates? Nobody knows the future, but we need to make assumptions and educated guesses to invest wisely.
Inflation looks like it may persist for 3-6 years. The US government pumped a lot of stimulus into the economy during the pandemic and afterward.
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The Federal Reserve hopes to drain the economy of this excess liquidity by raising interest rates. It may take some time for inflation to slow.
As inflation remains high, so will our Series “I” Bonds. However, as inflation subsides, our bond yields will deflate.
However, if we buy 30-Year Bonds with excellent yields (say over 5%), we can lock in these rates for a long time. So we play both sides of the fence.
Don’t forget that the Federal Reserve can keep its target rates high if inflation subsides. So if inflation is at 2% a year, the Federal Reserve can still keep their rates at 6%.
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They would do this to keep inflation low and prevent the economy from running hot. With low interest rates, there is usually some type of asset bubble in either bonds, stocks, housing, commodities, or cryptocurrencies.
Conclusion. With high inflation and low yields on 30-year Treasury, it is the season for Series “I” Bonds. However, once 30-Year Bonds get over 5%, I would make a dynamic shift over there.
Locking in 5%+ bonds would be ideal. Yes, rates may go higher, but earning a risk-free 5% is never bad.
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You can also earn capital gains with your 30-Year Bonds. If rates go back down to 2%, your 5% bonds will be worth a lot more. I am not a bond trader and would not attempt to sell them for capital gains.
I am a buy-and-hold investor; however, it is good to understand all of your investment options. In any environment, you can’t go wrong with Series “I” Bonds.
Either way, it’s good to take your dollars seriously. You can’t go wrong if you invest in building wealth slowly. There is always a better investment, but doing what is suitable for your future will yield the best results. Good Luck!
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