MoneyMagpie

Nov 18

Beat inflation with index-linked bonds

Reading Time: 4 mins

Savings that beat inflation? Unheard of! Well, certainly in these turbulent economic times. Index-linked bonds, however, may offer just that.

So, what are index-linked bonds, how do they work, and are they a good investment? Keep reading to find out!

What are index-linked bonds?

They are savings bonds which, instead of having a rate of interest set by the bank, track a certain ‘index’. Often this can be a particular stock market index, but in this case, it is the Retail Prices Index (RPI).

What’s the RPI?

The Retail Prices Index or the RPI is a measure of inflation (not the official one, but still used by the Government to make certain calculations). It’s also a popular measure of the cost of living.

The most recent RPI figures, in October 2019, showed inflation at 2.1%. Inflation was 1.5% in the same month. This discrepancy is normal: overall inflation based on the Consumer Price Index (CPI) doesn’t take into account costs like mortgage payments, rents, and council tax.

What does that mean for your money?

An RPI-linked bond means you’re likely to get more money back than a fixed-term bond (savings account). That’s because, for a fixed term bond, you’re only going to get the agreed interest rate. With index-linked bonds, you’ll get an agreed rate PLUS a calculated difference in the RPI (if it’s gone up over time).

As always, the longer you hold these bonds, the more likely it is you’ll reap rewards. Markets go up and down, but historically trend upwards overall.

Should you choose one over a standard savings bond?

What these accounts are essentially doing is protecting your money from being eroded by inflation. When you save, your savings don’t lose value in real terms (which is unfortunately what is happening with most other standard savings accounts).

Even if the rate of inflation drops into the negative, like it did in April 2015, inflation-linked bonds still have a base interest rate. You’ll still get the basic return on your bond: the link to inflation is in ADDITION to the basic agreed rate.

The best interest rate for a five-year fixed rate bond right now is 2.36%. Meanwhile, the best five-year fixed rate cash ISA at the moment offers 2.1%.

An inflation-linked bond offers the basic interest rate plus a rate linked to the RPI. So, if prices rise steadily, you’re in the money! If prices rise slowly, it takes longer to see great returns.

So, unlike a normal savings account, which doesn’t keep up with inflation, an index-linked bond can help you beat inflation! This keeps the buying power of your money strong.

What are the downsides?

You need to tie your money up for the agreed term of several years. If interest rates rocket during that time, you might not get the best returns compared to other investments.

However, the way things are at the moment (and have been for a while), that’s unlikely. The only way to make big money is to take huge risks. If you don’t want to take those risks, an inflation-linked bond is a relatively safe bet.

The only other downside, at the moment, is the limited options for index-linked bonds on the market. Banks have realised they could lose out, so it’s rare to find an inflation-linked savings account.

How do I get index-linked bonds?

The market for inflation-linked savings or bonds changes all the time. High-street and online banks and building societies do offer them, even if sporadically at the moment. A good way to find the best one is to use a comparison website like Moneysupermarket to find the top deals at the time.

NS&I, part of the Government’s Treasury, also offers index-linked savings certificates. However, these used to be calculated on the RPI. Now, from 1 May 2019, they’re calculated using the CPI. This means the returns are lower.

What else can you do to protect your money from inflation?

Inflation-linked bonds are hard to come by at the moment, unless you want a savings certificate with NS&I. If you want to try other ways to beat inflation, we’ve got a few ideas!

Check out how to use index-tracking funds on the stock market to beat inflation, for a start.

Try Peer-to-peer lending

You, the investor, lend money to individuals and businesses who won’t get a loan from the banks. It sounds risky, but wait!

Smaller businesses often struggle to get loan from banks, despite a great business plan. Banks seem much more interested in the ones trying to borrow millions of pounds instead of a few thousand (or hundred thousand).

That’s why Blend Network set up. They’re a P2P lending platform for property developers. Instead of lending to huge businesses, though, they focus on small developments. Flat conversions, small new builds, that kind of thing.

This helps contribute properties to alleviate the housing crisis – without creating property sold to international investors. Many large-scale and luxury developments don’t sell to UK residents: they’re sold to international investors who can rent them out for huge sums.

Blend Network funds smaller builds. In return, they offer a projected return of 12%. Yes, really! Of course, this isn’t guaranteed – but your returns could definitely beat inflation.

Two more popular P2P platforms with great reputations might suit you better: Zopa and Ratesetter. These offer all sorts of investment opportunities – ideal if you’re not interested in property investments.

You offer your money through their platform. They lend to the end business or individual at a slightly higher rate (say, 14%) and take their fees from the extra percentage. It’s win-win-win: you get some safety by lending via the platform, they make money, and businesses otherwise ineligible for loans can borrow!

Try Stocks and Shares ISAs

Finally, we always say this but we’ll say it again: open an equities ISA!

Stocks and shares ISAs offer a brilliant way to build tax-free savings with a little risk on the stock market. With ISA wrappers, pre-selected funds, or even robo-adviser investments, there’s a route for every type of investor.

You don’t need to have any experience with the stock market to invest. However, if you’ve never dabbled in stocks and shares before, check out our beginner’s investing guide here first!

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