The tough year for the stock market has many investors scrambling to find ways to earn some low-risk income. One particular type of investment that I’ve been asked about quite a few times in recent months is the I bond, officially known as the Series I Savings Bonds.

They are 30-year bonds issued by the U.S. Treasury Department and they are backed by the U.S. government. Thus, they are considered to be “riskless.” (Whether you consider the creditworthiness of the U.S. government as truly riskless is another question.)

What has caught investors’ eyes this year is the 9.62% yield currently offered by these I bonds. To get this rate you must purchase the bond before the end of October 2022 because the rate will reset on the first business day of November. So if you are interested, you have a few more weeks left.

The 9.62% print is the highest ever. How does a government bond, considered to be riskless, offer such a high yield?

You can thank record-high inflation for that.

Buoyed By Inflation

You see, the I bond interest rate consists of two parts. There’s a fixed component and a floating component that’s based on the inflation rate for the previous six months as indicated by the non-seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) for all items, including food and energy.

The fixed rate will remain the same until the maturity of the bond. On the other hand, the floating rate will reset every six months, on the first business day of May and November.

At the last rate reset, the fixed rate was set at zero—it’s actually been repeatedly set at zero since November 2019. But the semi-annual inflation rate was determined to be 4.81% and so the floating rate was set to 4.81%. Annualized, that results in the 9.62% interest rate.

So let’s say you buy $5,000 worth of the I bond on October 5 with the interest rate at 9.62%, you will be credited $240.50 for the next six months—0.0962 ÷ 2 x $5,000. Then in April 2023, the rate will reset and you will be subject to the prevailing rate in effect that that time (the next rate will be determined in early November 2022) for the next six months. The interest received will compound as well at the new rate.

Not Without Some Drawbacks

With the stock market so volatile lately, you may wonder why people don’t just buy the I bonds hand over fist. The reason is that the government limits I bond purchases to $10,000 per calendar year per person.

You won’t be able to cash out for at least one year. And if you cash out within the first five years, Uncle Sam will keep three months of interest as penalty. Thus, if you buy the I bond, prepare to have the cash be locked up for a while.

Furthermore, if inflation falls, then the interest rate on the I bond will fall as well. Only the fixed rate is locked in. Since the fixed rate is currently zero, your return will depend entirely on inflation. If inflation falls into negative territory, you could earn a negative interest rate for that period. Thus, while there is little default risk, there is inflation risk.

Beware that although you are indeed buying a Treasury bond with a 9.62% interest rate, the actual return you earn over whatever period you hold the bond could deviate substantially from that rate.

I bond interests are exempt from state taxes but are subject to federal taxes. You can choose to report the interest every year and pay taxes or defer reporting the interest until you cash out or the bond matures.

To buy I bonds, you will need to set up an account and buy them directly from treasurydirect.gov.

Editor’s Note: Our colleague, Dr. Joe Duarte, has devised a simple, groundbreaking technique for making money…and it works in bull or bear markets, in economic expansions or contractions.

You’ll be able to set yourself up for a shot at pocketing steady income, week after week, with Dr. Duarte’s “instant cash codes.” To learn more, click here.