How do Savings Bonds Work as Defensive Investments?
As retail investors diversify outside of an equities-only portfolio, many are looking at savings bonds as an opportunity to capitalize on rising interest rates. Historically, they are one of the oldest and most trusted investment products. They’re backed by the full faith and credit of the United States government, and they offer investors options to both preserve and grow their wealth. They’re widely considered a defensive investment and tend to rise in popularity as the stock market falls on hard times.
Let’s take a closer look at savings bonds: what they are, how they work as investment vehicles and how to best leverage them into a defensive portfolio. Plus, we’ll look at the role of savings bonds within the context of a recession.
What is a Savings Bond?
A savings bond is a long-term depository investment made with the United States Treasury. They offer investors a guaranteed rate of return on their money, depending on how long they hold it. There are actually two types of savings bonds investors can consider:
- Series EE. These bonds offer a fixed rate of return that will double the face value after a period of 20 years. They’re available in denominations ranging from $25 to $10,000, capped at $10,000 per year, per taxpayer. Investors need to hold these bonds for at least one year before selling, and there’s a penalty amounting to three months’ interest if sold within five years of purchase.
- Series I. These bonds adjust their interest rate every six months based on inflation. Like Series EE bonds, investors can purchase Series I bonds in increments ranging from $25 to $10,000, capped at $10,000 per year, per taxpayer. A type of zero-coupon bond, investors gain the full bond payout when it’s cashed in. There’s a penalty amounting to three months’ interest if sold within five years of purchase.
Savings bonds are the ultimate “set it and forget it” investments because, unlike other ones that pay interest and fluctuate based on the bond market, these investments are best held for the long-term. It’s best to invest in them when your time horizon on realizing their gains is 20-30 years.
Series HH savings bonds were also available from 1980 through August 2004. These bonds had a maturity date of 20 years and functioned similar to Series EE bonds, though they paid interest bi-annually. Investors who still hold Series HH bonds can continue to collect interest on them or cash them in at face value.
Savings Bonds vs. Other Treasuries
Savings bonds are one type of U.S. Treasury product, alongside T-Bills, T-Notes, T-Bonds and Treasury Inflation-Protected Securities (TIPS). The key difference between savings bonds and other U.S. Treasuries is rate of maturity. T-Bills mature in less than 52 weeks. T-Notes mature in less than 10 years. T-Bonds mature in 20-30 years and pay interest, unlike savings bonds, which deliver ROI at the time of redemption.
It’s often simpler to think about savings bonds as deposits that earn interest, whereas other U.S. Treasuries are debt investment products. They work similarly to a savings account.
The Major Benefits
Given the option to put your money in savings bonds vs. a savings account (or even a debt investment), savings bonds offer some excellent benefits to consider. Some of the primary reasons you might invest include:
- The earnings they generate are exempt from state income taxes
- You can also avoid federal taxes if you use the earnings for education
- There’s a low barrier to entry; they are available for as little as $25
- Redeemable with no penalty after five years
- Backed by the full faith and credit of the United States Government
Savings bonds offer interest-earning opportunities, combined with the flexibility to either let your money grow risk-free for 30 years or pull it out penalty-free after five years. They’re also very accessible to any investor.
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How to Use Them in a Recession
If you’re looking to hedge your portfolio and take a more defensive stance against oncoming economic hardship, savings bonds can provide stability. That said, they’re better for those seeking very long-term defensive investments. Depending on the type of one you buy (Series EE vs. Series I), each has its own grouping of pros and cons. Nevertheless, either represents the safest possible investments you can make.
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