Where do IBonds fit in your portfolio?

I was a little surprised to see the real interest rates were actually at the most 1% if not less. Most banks have savings rate of 3.5% but the inflation is around 3%. Currently the rate of I Bonds is 6.73%. You can read more about I Bonds at treasurydirect.gov. I am sure this gives no way even close to the ROI results you get when investing in the market over a long run, but this is certainly lot better than the savings account.

Here are the advantages and disadvantages of IBonds that make it better than savings but little less liquid. In my previous post I mention what role do savings account play.

Advantages

• Liquid asset. It is the closest to cash/savings compared to any other investment vehicle.
• Guaranteed rate of return. This has fixed rate of return + variable rate based on semi annual inflation based on CPI.
• Inflation protected, thus you don't have to worry about inflation at all.
• Local and State tax exempt.
• You never lose money as these are U.S. govt. backed.

Disadvantages

• Withdrawal limits. One cannot withdraw within one year of ownership. You need to own them for at least one year. If money is withdrawn within 5 years there is a 3 month most recent 3 months interest penalty.

I think these bonds are great place to keep most of your savings after 5 years but you can't keep all your savings in IBonds as there is a 3 month interest penalty if you withdraw before 5 years. So, in case of emergency before 5 years, you might loose some money but the difference in ROI still makes it worthwhile keeping 80% of your savings after 15 months. Thus, start with keeping some of your savings in IBonds and after a year start moving funds slowly. This is almost like a CD except that the rate is inflation protected in IBonds and there is absolutely no penalty to withdraw anytime after 5 years.