I-Bond Yields Set to Plunge Below 4% – Where's a Safe Yield Now?

I-Bonds have two components: a fixed rate and a variable rate. While both rates are a mystery, the fixed rate generally reflects long-term interest rates while the variable rate adjusts for inflation. The variable rate resets every six months, but the fixed rate remains for the bond’s life, making it more impactful if the bond is held to term.

In May, the variable rate is sure to decrease amid lower inflation levels, but the fixed rate could increase from its current 0.4% level. If that happens and investors plan to hold the bond until maturity, the benefit of a fixed rate increase could offset the impact of the lower variable yield due to declining inflation in the near term.

Ultimately, investors who plan to hold the bond for one or two years may want to lock in the current rate for six months, while those who intend to keep the bond until maturity may wish to wait for a higher fixed rate. But investors seeking high yield for more than six months may want to look elsewhere as the inflation rate continues to fall.

Municipal bonds are recovering after rising interest rates sent prices lower last year. While recovering prices translate to lower yields, longer-dated bonds remain attractive. Muni bonds maturing in 15 to 30 years offer AAA-rated exposure, a 3-4% yield (5%+ after-tax in some cases), and prices that have yet to recover fully from last year’s sell-off.

If you can’t reap the tax advantages of a muni bond, Treasuries offer another AAA-rated alternative with attractive rates. Rising interest rates have made Treasuries more attractive while falling inflation could help prices recover. For example, the iShares 20+ Year Treasury Bond ETF (TLT) is up 7.35% year-to-date with a 2.64% yield.

Investors willing to assume a little more risk may also want to consider alternative yield-focused strategies. For example, dividend stocks, real estate investment trusts (REITs), and oil and gas pipelines offer high-yield opportunities and equity upside potential. In addition, investors may consider strategies like covered calls to boost income.

Here are some alternative funds, sorted by yields, to consider:

 

When choosing the right option, investors should consider their yield requirements, risk tolerance, and upside potential. For instance, municipal bonds may offer a low-risk yield without upside, dividend stocks offer a higher-risk yield with upside potential, and covered calls offer attractive yields with capped upside potential.

I-Bond yields are set to fall in May, which raises some important questions for investors. While long-term holders may appreciate the opportunity to lock in a higher fixed rate, short-term holders may want to act sooner to lock in a higher variable rate or look elsewhere for yield. Fortunately, there are many opportunities in today’s market.

Take a look at our recently launched Model Portfolios to see how you can rebalance your portfolio.