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Should I Put My Emergency Fund in I Bonds?

Michael Reynolds | January 31, 2023

[Prefer to listen? You can find a podcast version of this article here: E161: Should I Put My Emergency Fund in I Bonds?]

I Bonds have been getting some extra attention lately due to inflation that is higher than normal and the corresponding interest rate currently available with I Bonds.

If you’re not familiar with I Bonds, you can learn more about them in this podcast episode: E142: An Overview of "I Bonds".

As a basic refresher, however, I Bonds are issued by the U.S. Government and are designed to pay interest at a rate that corresponds with the current rate of inflation.

You can buy up to $10,000 in I Bonds electronically per year per social security number or tax ID. I Bonds cannot be cashed out for one year from date of purchase. After that, they can be sold but the last three months of interest is forfeited if it is within five years of purchase. Interest earned on I Bonds is not subject to state or local income taxes.

So what role can I Bonds play in your financial plan?

While they don’t really make sense as an investment (since the interest rate is not designed to outpace inflation), I Bonds can serve as a vehicle for others parts of your financial plan, including your emergency fund.

Your emergency fund is meant to be a safety net or self-funded insurance policy against unexpected expenses. For this reason, your emergency fund should be funded with assets that are:

  • Liquid
  • Are not at risk for losing value

You want your emergency fund to be accessible when you need it and also want it to be “stable” and retain its principal balance.

Based on these requirements, the ideal place for an emergency fund can include savings or money market accounts.

While these accounts provide the safety and liquidity required, one downside is that money in these accounts will typically not keep pace with inflation. This leads to decreased effective value over time.

So if you’re concerned about inflation, what other options are there for an emergency fund?

This is where I Bonds shine.

Since I Bonds are designed to keep pace with inflation, they can make an ideal vehicle for an emergency fund for those concerned about losing purchasing power over time with cash.

But what about liquidity? Since I Bonds are “locked” for one year after purchase, short-term liquidity is an issue. If you convert your entire emergency fund to I Bonds and your car breaks down a week later, you are stuck without an emergency fund.

Because of this, a slow migration to I Bonds can be a very effective way to build an emergency fund with I Bonds.

One scenario is the “multi-year drip funding” option. In this scenario let’s assume your emergency fund is $10,000. You could take $1,000 of your emergency fund each year and purchase I Bonds. This gradually shifts your emergency fund from cash to I Bonds over the course of 10 years. It does reduce your emergency fund by 10% but this is s fairly low-risk reduction assuming it’s fully funded.

Because you are “laddering” the purchases in one-year increments, you are maintaining liquidity in all but 10% since the I Bonds become liquid after one year.

If you don’t want to wait that long, there can be cases where a faster migration is possible without taking on too much risk. For example:

  • Do you have liquid investments that can act as a supplement or a “backup” emergency fund during the transition?
  • Is your household income stable enough to allow for a reduced emergency fund for a period of time?
  • What is your debt situation? Zero or low debt reduces your risk profile.
  • Is your life and disability insurance current and adequate?
  • Do you have other safety nets or sources of liquidity that lower your risk?

If your personal situation supports it, it may be feasible to migrate in a shorter amount of time. For example, converting at a rate of 25% per years results in migrating your emergency fund to I Bonds in four years.

While one advantage of using I Bonds for your emergency fund is that it keeps up with inflation, there is another practical benefit: friction.

An emergency fund is meant to be a stop-gap for unexpected expenses. However, it’s not uncommon for these funds to be raided for other things when temptation strikes, such as vacation, cars, and other non-emergency purchases.

It can be challenging to resist cash that is readily accessible.

However, I Bonds come with a lot of friction. Simply logging into the Treasury Direct website requires jumping through all sorts of hoops and login quirks. And it doesn’t link up with any other tools so you can’t see your balance using any common finance apps.

Because I Bonds are so “out of site out of mind”, they can be a very effective way to manage your behavior when it comes to preserving your emergency fund.

To summarize, I Bonds can be a great place to keep your emergency fund because of the following benefits:

  • Keeping up with inflation.
  • Creating useful friction that discourages inappropriate use.

An important caveat: it is still important to have some cash on hand in a regular bank account. Even if most of your emergency fund is in I Bonds, keep a decent buffer in savings for things that are truly immediate needs. You need to have proper liquidity in the event that you can't wait for the redemption and transfer process to get money from your I Bonds.

If these benefits appeal to you and you feel comfortable with a migration path, I Bonds could be a great place for part or even all of your emergency fund.