Part 3: Series I-Bonds: Five Investments for High Inflation

My recent article titled "ECRI Global Inflation Outlook - Higher Inflation Ahead" showed that inflation pressures are building globally. In the United States, December CPI came in at 2.7%.

Just last week, ECRI, the Economic Cycle Research Institute, said "With the USFIG now advancing for ten straight months, underlying inflation pressures are in a sustained cyclical upswing, promising higher inflation in the coming months." Even in Japan, the threat of persistent Japanese deflation "continues to recede."

In this series of article I will discusses five investments that should do well in an environment of higher inflation. These are

1. Part 1: Gold
2. Part 2: Cash
3. Part 3: Series I-Bonds
4. Part 4: TIPS and TIPS Funds
5. Part 5: Commodities

Part 3: Series I-Bonds

Series I Bonds (or iBonds) are a low-risk, liquid savings product. They are 100% backed by the US government and its ability to tax and print money. While you own them, they earn interest and protect you from inflation. Unlike Treasuries that pay interest at regular intervals, iBonds compound the interest similar to CDs. The rate you get for iBonds changes every six months based on the rate of inflation. You collect the interest and pay the taxes on the gains when you cash them in so they are a great way to defer taxable income.

Earnings rates for I bonds are set each May 1 and November 1. Interest accrues monthly and compounds semiannually. Bonds held less than five years are subject to a three-month interest penalty. I Bonds have an interest-bearing life of 30 years. When the inflation rate is less than zero, a bond's earnings rate is less than its fixed rate (but the earnings rate is never less than zero)

The current I Bond Earnings Rate is 3.36%

The earnings rate for Series I Savings Bonds is a combination of a fixed rate, which applies for the life of the bond, and the semiannual inflation rate. The 3.36% earnings rate for I bonds bought from November 2009 through April 2010 will apply for their first six months after issue. The earnings rate combines a 0.30% fixed rate of return with the 3.06% annualized rate of inflation as measured by the Consumer Price Index for all Urban Consumers (CPI-U). The fixed rate applies for the 30-year life of I bonds purchased during this six-month period. The CPI-U increased from 212.709 to 215.969 from March 2009 through September 2009, a six-month increase of 1.53%.

I Bond Composite rate = [Fixed rate + (2 x Inflation rate) + (Fixed rate x Inflation rate)]

Inflation Bond Facts:

• I Bonds earn interest from the first day of their issue month.
• You can redeem them at any time after a twelve-month minimum holding period
• They are an accrual-type security
• They increase in value monthly and the interest is paid when you redeem the bond
• I Bonds are sold at face value; i.e., you pay $50 for a $50 I Bond
• I Bonds grow in value with inflation-indexed earnings for up to 30 years
• If you redeem I Bonds before they’re five years old, you’ll forfeit the three most recent months’ interest; at or after 5-years, you won’t be penalized.
• Annual rates compounded semiannually
• Maximum purchase (per calendar year) is $10,000:
  $5,000 in TreasuryDirect and $5,000 in paper bonds

You may purchase I Bonds at www.TreasuryDirect.gov and at most local financial institutions.

Best Time to Buy I Bonds: Near the end of the month. Make sure you leave enough time for funds to clear.

Best Time to Sell I Bonds: At the start of the month since interest for the prior month is computed on the first of each month. You don't earn interest for fractional months so sell only after the new interest shows up in your account, usually the first of the month.

Disclosure: I own TIPS, TIPS mutual funds and Series I-Bonds. I also own and cover them in my newsletters. See Kirk's Two Investment Letters for more information.

More about Series I Bonds

• Composite Rate History
  
  
• Fixed Rate History
  
  
• CPI Table

Next: Come back later to read the next article in the series "Five Investments for Higher Inflation:Part 4: TIPS and TIPS Funds "

Disclosure: I sold all my bonds and bond funds not indexed to inflation. Besides cash in many CDs and savings accounts, I own TIPS, TIPS mutual funds and Series I-Bonds. I also own and cover these investments in my newsletters. See Kirk's Two Investment Letters for more information.

Part 2: Cash: Five Investments for Higher Inflation

My recent article titled "ECRI Global Inflation Outlook - Higher Inflation Ahead" showed that inflation pressures are building globally. In the United States, December CPI came in at 2.7%.

Just last week, ECRI, the Economic Cycle Research Institute, said "With the USFIG now advancing for ten straight months, underlying inflation pressures are in a sustained cyclical upswing, promising higher inflation in the coming months." Even in Japan, the threat of persistent Japanese deflation "continues to recede."

In this series of article I will discusses five investments that should do well in an environment of higher inflation. These are

1. Part 1: Gold
2. Part 2: Cash
3. Part 3: Series I-Bonds
4. Part 4: TIPS and TIPS Funds
5. Part 5: Commodities

Part 2: Cash

Cash in savings accounts is one of the most conservative investment for rising rates. Cash is currently losing one to two percent a year to inflation as of the last reading, but until recently, cash was beating inflation. The idea with cash is you can usually get close to the current rate of inflation if you shop around. It is not perfect but it beats what could happen to bond funds should interest rates suddenly surge or bond investors sour on bonds.

Bonds will probably lose NAV (net asset Value) when rates go up but cash in FDIC and NCUA insured savings accounts is always worth a dollar per dollar saved plus you get higher savings account rates as rates go up.

I have a good deal of my money that would be or was in Vanguard and Fidelity's total bond funds (VBMFX Quote and Charts) and GNMA funds (VFIIX quote and Charts) now invested in savings accounts paying between 1.20% and 1.30% per year. I have it split between several banks and credit unions so I can get full FDIC and NCUA coverage. Currently you can get 1.50% at American Express Bank and 1.49% at Ally Bank. For more choices, see the February 9, 2010

• Savings Account Rate Survey

I have critical mass (enough money to retire should I wish to stop working) so I am far more interested in preserving assets than taking risk with the fixed income side of my portfolio. I take plenty of risk with equities, especially in my "explore portfolio" where I have significantly out performed the indexes over the very long time. Of course, this great performance comes with considerable volatility so I want the fixed side of my portfolio solid to allow me to sleep well at night. That means I don't chase yield.

Of course, with CPI-U inflation now at 2.7% and expected to go up, money in short term savings and US Treasuries is losing ground to inflation. I like savings accounts over US Treasuries because the rates are better so less is lost to inflation.

For current rates, see US Treasury Rates - Quotes at a Glance

If you don't need the money for a year, CDs are another way to lock in a rate if you are worried the rates on savings accounts will continue the trend to go lower and lower each month.

See Best CD Rates - Top CD Rate Survey by Term

Next: Read the next article in the series "Five Investments for Higher Inflation: Part 3: Series I-Bonds "

Disclosure: I sold all my bonds and bond funds not indexed to inflation. Besides cash in many CDs and savings accounts, I own TIPS, TIPS mutual funds and Series I-Bonds. I also own and cover these investments in my newsletters. See Kirk's Two Investment Letters for more information.

Part 1 Gold: Five Investments for Higher Inflation

My recent article titled "ECRI Global Inflation Outlook - Higher Inflation Ahead" showed that inflation pressures are building globally. In the United States, December CPI came in at 2.7%.

Just last week, ECRI, the Economic Cycle Research Institute, said "With the USFIG now advancing for ten straight months, underlying inflation pressures are in a sustained cyclical upswing, promising higher inflation in the coming months." Even in Japan, the threat of persistent Japanese deflation "continues to recede."

In this series of article I will discusses five investments that should do well in an environment of higher inflation. These are

1. Part 1: Gold
2. Part 2: Cash
3. Part 3: Series I-Bonds
4. Part 4: TIPS and TIPS Funds
5. Part 5: Commodities

Part 1 Gold

Gold is the traditional investment people use to hedge for high inflation. Gold is also a popular hedge for an "Armageddon Type" disaster but I prefer a portable water filter that I can use to make clean drinking water to trade for whatever I need.

Obviously Gold was a much better investment ten years ago when it was 79% lower.

Click chart courtesy of stockcharts.com for full size image

Gold's price may have already anticipated future inflation. After all, the US and most other nations have been running budget deficits for a decade while gold has soared. Also, if you need more gold, you can hire people to dig it out of the ground for you. This could increase supply if wages remain low relative to inflation. Of course, if governments across the globe continue to spend like crazy and print money, then currencies could crash and gold would soar far higher.

How to Buy Gold

• You can buy gold bars and store them yourself. Don't forget the cost of insurance, security systems and storage costs when calculating your return.
  
  
• You can buy gold coins and store them yourself. There is usually a large amount lost on the "bid ask spread." That means if you pay a dealer $1,000 to buy a gold coin, make sure to ask what he's willing to buy it back from you for. Before he knows you are considering buying, ask what he'll pay you for the coin you are interested in.
  
  
• You can buy gold mining stocks. With so many people willing to work for low wages around the globe, the cost of extracting gold from the ground might not go up nearly as fast as inflation. This would be good for gold mining stocks but maybe not for the metal itself. Of course, poor management or fraud could sink a gold mining stock even if gold soars so diversification is wise to spread specific stock risk.
  
  
• You can buy the ETF (exchange traded fund) for gold which has the symbol GLD (GLD Quotes and Charts). This would be my first choice as a way to buy gold other than the few small pieces I have hidden around the house worth a few hundred dollars for emergencies.

Disclosure: I sold all my bonds and bond funds not indexed to inflation. Besides cash in many CDs and savings accounts, I own TIPS, TIPS mutual funds and Series I-Bonds. I also own and cover these investments in my newsletters. See Kirk's Two Investment Letters for more information.

Charts and current quotes for:

• SPDR Gold Trust ETF
  
• Gold Prices
• CRBQ
  
• TIP
  
• VIPSX

Next: Read the next article in the series "Five Investments for Higher Inflation: Part 2: Cash"

Gold Quote:

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View the full FUTURE:GC00 chart at Wikinvest

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