Calculating the I Bond Rate

The I-bond rate is actually made up of two separate interest rates. The Treasury I-bond's first interest rate is set on purchase; it never changes throughout the life of the bond. The second interest rate goes up and down with inflation. The sum of these two interest rates is the actual interest rate on the bond. This rate is set semiannually on Treasury bonds, meaning the rate will be different every six months.

Advantages of I-Bonds

One of the main challenges inherent in Treasury bonds is a relatively low interest rate. This low interest rate is possible only because Treasury bonds are considered to present zero risk of default. The biggest risk, then, is that inflation will outpace the interest rate over the life of the bond. For example, if you were to place $100 in a Treasury bond at a rate of 1.6 percent for 10 years, you would lose money on the investment if inflation rose more than 1.6 percent during that same time period. Even though you would receive your principal $100 in return, you may have actually made more money on interest by simply putting the money into a savings account during the same period. With an I-bond, the chance you will lose money on the investment due to inflation is completely eliminated.

I-Bond Example

In the above example, imagine you purchased a $100 Treasury I-bond at the set interest rate of 1.4 percent. Inflation rose by 2 percent over the 10-year period. As a result, your actual interest rate would be 3.4 percent over the 10-year period. Of course, this interest rate was raised periodically as inflation raised. Therefore, there were months when your rate was less than 3.4 percent, and there may even have been months when your rate was higher. On average, though, over the life of the bond, your interest rate was the equivalent of 1.4 percent plus the going inflation rate. It is important to note that, even though it is possible for deflation to drop the interest rate you are receiving on the bond, your interest rate can never drop below 0 percent on an I-bond.

I-Bond Alternative

I-bonds are not the only inflation-protected options presented by the Treasury. TIPS bonds also have inflation protection. These bonds are issued with a set interest rate as well, but the way inflation is calculated is unique. Instead of having two separate rates, these bonds allow the principal amount of equity to rise and fall with inflation. So, while the interest rate is constant, the value of your actual investment will be adjusted for inflation twice annually. The result is effectively the same as an I-bond calculation. One difference, though, is that you may receive a higher return value at the time the bond reaches maturity than you would see with a comparable I-bond. Ultimately, both bonds offer extremely risk-free investment options. This means, unfortunately, that they are also relatively low profit when compared to other options on the market. 

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