With inflation hovering at 3.5%, leaving your money in a basic savings account can cost you money; the average interest rate on a savings account is just 0.46%. That means the interest you earn on your savings account may not keep pace with inflation.
To maximize your return, stashing your money in a Series I savings bond, more commonly known as an I bond, or a (HYSA) can be a smart alternative. Both of these products offer higher returns than , but there are some key differences to be aware of before deciding where to put your money.
What are I bonds?
Series I bonds are available through the , backed by the full faith and credit of the U.S. government.
The appeal of I bonds is in their two-pronged approach to interest: I bonds earn both a fixed rate of interest and a variable rate. The fixed rate stays the same for the life of the bond. The variable rate is tied to inflation and changes twice a year to coincide with changes to the Consumer Price Index for all Urban Consumers () — a benchmark that economists use to calculate the change in prices that consumers price for common goods and services.
What does that mean for you? You earn a guaranteed rate of interest with the fixed-rate portion of the I bond, but you’ll also earn the variable rate. Because I bonds can change along with market conditions, they can be a useful hedge against inflation.
For bonds issued between November 2023 and April 2024, the combined rate — the I bond rate calculated from the fixed and variable rate — is 5.27%.
I bonds earn interest for 30 years. Interest is earned monthly, but it’s , or added to the principal, every six months. Once you’ve held the bond for at least 12 months, you can cash it in. However, if you cash in I bonds before you’ve held them for at least five years, you’ll sacrifice three months of interest.
Pros
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Guaranteed return: Because I bonds have a fixed-rate component, you have a guaranteed rate of return on your money. Right now, the fixed-rate portion is 1.30%.
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Higher rate of return: Currently, the combined rate of I bonds is set at 5.27%, which is significantly higher than the average return you’d find with a traditional savings account, , or (CD).
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Exempt from state or local taxes: Although Series I bonds are subject to federal income taxes, they’re exempt from state or local taxes, helping you save money.
Cons
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Maximum limits apply: You can only buy up to $10,000 in electronic I bonds and an additional $5,000 in paper I bonds with your tax refund for a combined maximum of $15,000 per year. If you’re trying to save a larger sum, you’ll have to find another tool for the excess amount.
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Must be held for one year: I bonds cannot be redeemed or cashed until you’ve held them for at least 12 months. If you have an emergency expense within the first year of owning an I bond, you won’t be able to tap into your bonds to cover the cost.
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Some withdrawals will result in loss of interest: Although you can cash in an I bond after 12 months, redeeming it within the first five years of its purchase will cause you to lose three months’ worth of interest.
What are high-yield savings accounts?
Traditional savings accounts are tools for saving for emergencies or other financial goals. However, traditional savings accounts have low APYs, so a HYSA can be a valuable alternative.
Often available from or , HYSAs provide significantly higher-than-average rates; we analyzed the rates of savings accounts offered by 15 credit unions and banks and found that these accounts offered an average annual percentage yield (APY) of 4.31%.
Savings accounts allow you to transfer money to or brokerage accounts quickly and easily, and there’s no penalty for withdrawing money before a certain period of time has passed.
However, that rate is variable, and it can change at any time, so there’s no guarantee of future returns.
Pros
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Liquid: With a savings account, you aren’t required to leave your money untouched for months at a time. You can transfer money or make withdrawals without losing the accrued interest.
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Higher-than-average rates: HYSAs provide substantially higher APYs than you’ll find with other deposit accounts, including traditional savings accounts, CDs, or money market accounts.
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Low deposit minimums: Many HYSAs have no minimum deposit requirement, so you can open an account with $0.
Cons
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May have monthly fees: Some HYSAs charge monthly fees that can only be waived if you meet certain requirements, such as maintaining a minimum balance or receiving direct deposits.
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Rates can change: The rates on HYSAs are variable, and banks or credit unions can change the rates at any time.
I bonds vs. HYSAs: Key differences
Series I bonds and HYSAs can be useful tools for fighting inflation. When deciding which option is better for you, consider these key factors:
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Initial investment: HYSAs usually require $0 to open an account, while an I bond requires at least $25.
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Maximum limits: There is no maximum to how much you can deposit into a HYSA (though and insurance only ). By contrast, there is an annual maximum of $10,000 in digital I bonds, and $5,000 in paper I bonds when purchased with your tax refund.
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Compounding: With HYSAs, interest is typically compounded daily and added to your account monthly. With I bonds, interest is earned monthly, and it’s added to the bond’s principal value twice per year.
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Fees: I bonds don’t have monthly fees. Although there are fee-free savings accounts, some HYSAs do charge monthly fees.
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Rates: The rate of an HYSA can change as market conditions fluctuate. With I bonds, there is a fixed rate of interest and a rate that’s tied to inflation, so they provide more surety.
I bond vs. savings account: Which is better?
Which type of account makes the most sense depends on your goals and intended use for your money. HYSAs provide quick and easy access to your money, and the offer significantly higher-than-average rates. However, those rates can decrease over time. I bonds may be a better option for those who want the combination of guaranteed returns and a variable rate that changes along with inflation.