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It’s one of the most pressing questions of the day – how do you find a safe way to protect your wealth against inflation?
Gold has been the first port of call during the money printing frenzy of the last few years. But in recent months, many investors have been looking for a more stable alternative – one that will protect against inflation and not cause you to lose any sleep.
Maybe that explains why the re-launch of the National Savings & Investment (NS&I) inflation bond caused such a stir this week. Over the next few months, I expect to see investors queuing around the block for this investment.
Why the banks killed this great bond
You may remember the original NSI inflation-busting bond. It promised to pay 1% above inflation but was whipped off the market last July.
It offered tax-free returns on a bond linked to an ever-climbing inflation rate and all backed by the state, so of course it had to be withdrawn. The struggling banks just couldn’t compete with a government-sponsored giveaway.
But today things are different. Now the sun is shining on the banks and it’s the government that’s struggling. So the government-backed bond is back. They’re expecting some strong sales.
And on the face of it looks a good option. But I’ve taken a close look at this offering. And I think you need to be wary. And as I’ll show you in a minute, one Right Side reader may have unearthed an even better inflation busting investment.
Let me start by explaining why I think NS&I could catch a great deal of private investors over the next few months…
The treasury badly needs funds
The Treasury has told NS&I to go out and find some cash. The new NS&I bond is looking to raise £2bn from British investors. And that probably won’t be a problem. I mean, they’ve got a great marketing story.
First, income on these bonds is tax-free – not many issuers can offer that!
Second, these bonds were withdrawn because of huge demand from investors. Now they’re being issued again, there’ll be a queue of investors just waiting for their inflation-linked returns. After all, inflation has whipped itself up to 5.3%.
But this is what a lot of investors are missing: things have changed since last July.
The second bite of the cherry isn’t so sweet
Let’s start with the interest. Before the bonds were withdrawn they promised you 1% above inflation (RPI). But this time around they’re only promising 0.5% over RPI.
And the second problem is the inflation rate itself. When NS&I withdrew the bond, commodities were on the rise and the pound was in the doldrums. Both these factors were stoking up inflation. But we’ve already suffered that inflation. Commodities have recently fallen back and the pound has stopped falling. And with austerity plans kicking in, inflation will surely fall back towards the end of the year.
In fact, if you look at the NS&I five-year fixed interest bond (also released this week), it’s offering a more sober 2.25% fixed for five years. It looks like NS&I are expecting inflation to fall way back – and I agree.
I fear that investors are being suckered in at the worst moment, convinced that yesterday’s inflation is here to stay. But if I’m wrong and inflation becomes intractable, you may want to consider another play…
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Is there a better way?
As I said last week, I like the argument for both inflation and deflation. I know it’s not fashionable, but I still err on the side of deflation hitting us first. And that’s why I recommended a bond that could benefit from both.
But if you’re looking for pure inflation protection, then RBS has another offering which one eagle-eyed Right Side reader alerted me to: “I’m not so worried about deflation so have gone instead for another similar inflation-linked bond from RBS”
The bond is traded on the Stock Exchange’s ORB (RBPX) and you can pick it up via most regular stockbrokers. It pays out 1.3 times inflation and will cover you until the end of 2020. The NS&I certificate, on the other hand is only good for five years.
RBPX RBSPP FLOORED FLTG RTE NTS 06/12/20
Source: London Stock Exchange
Right now the bond yields around 7% (much better than the 5.3% NS&I offering). But if inflation falls back to 2%, then the two bonds pay out about the same. If we hit deflation, you may well find yourself with no interest at all (which is why I plumped for my inflation/deflation bond).
Where this RBS bond comes into its own is if inflation takes off. It’ll start to look pretty smart with its RPI + 30% payout. So if your portfolio is particularly susceptible to inflation (ie you hold a lot of cash and bonds) then an allocation to this bond could offer a decent hedge.
Of course, there’s a tax issue here. The NS&I bond offers tax-free income. So for the RBS bond to be comparable, you’ll have to tuck it away in your ISA. Or you could pop it in your Sipp.
Bear in mind that the NS&I bond has an explicit government guarantee. The RBS bond does not. The bond isn’t even covered by the FSCS – the Financial Services Compensation Scheme.
The FSCS may pay compensation if an authorised company gets into trouble. With this bond, there’s no FSCS cover, so if RBS goes bust, you may not get all your money back.
If safety is your primary concern, then by all means go for the NS&I bond. But just remember, it’ll never pay you out a positive ‘real’ return on your money. The best you can ever hope for is to keep up with inflation.
To find out more about the RBS bond and download a full factsheet on the product, see: inflation multiplier bond.
Important information
Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Past performance and forecasts are not reliable indicators of future results. Commissions, fees and other charges can reduce returns from investments. Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Please note that there will be no follow up to recommendations in The Right Side.
Managing Editor: Frank Hemsley. The Right Side is issued by MoneyWeek Ltd.
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