I want to keep an amount of money stashed away, to be used in about three years' time. I am interested in buying inflation linked RSA Retail Savings Bonds, because the interest earned on cash is so pathetic. These bonds promise, if I understand correctly, to pay back your capital amount plus CPI plus one percent. If so, then this is a "can't lose" investment, not so? I mean, you're not going to get rich beating inflation by a percent, but at least you know, whatever the prevailing interest rates, that you're keeping up with inflation (plus a bit).
Is my assessment of Inflation Linked RSA Retail Savings Bonds correct, or am I missing something? To me it seems crazy to put your money in the bank for three years when these government bonds offer so much, comparatively speaking. Or is there a catch?
Retail Savings Bonds (RSBs) have become a little more popular since cash rates are in negative real returns (return less than inflation). There are a few options to choose from and the one you refer to is their three year inflation linked bond which, as you mentioned, yields what ever the prevailing inflation rate is plus one percent.
The key principal in any lender/borrower relationship is that the longer the term, generally the better the return. As you would have noticed; a money market account with a one day access will be lower than a 90-day fixed deposit with the bank.
Remember, banks generally only have terms of one year or less whilst the RSBs start at two years and increase up to five years.
Although offering a better yield than cash, or shorter term fixed deposits, one shouldn’t be lulled into the perception that you are necessarily beating inflation. The reason for this is that all interest accrued within the savings bond is taxable (as it is in the bank products).
Interest exemptions aside and assuming a return of seven percent (long term average CPI of 6 percent + one percent), along with a maximum tax rate of 40 percent, your net yield after tax would be closer to 4.2 percent and therefore lower than inflation.
The other aspect to consider, and one that contributes to the higher yield, is that of liquidity. Your capital is tied up within the bond for that full period so you must be absolutely certain that you do not need to access that money during the period.
Should you require cashing in, your bond holding will be "sold" on a secondary market at a price that appeals to this market. This could be a good thing or a bad one. The reason for this is that the capital value of a bond will increase and decrease along with interest rate assumptions. Because they have an inverse relationship with interest rates, the capital value will decrease when interest rates rise and increase when interest rates fall. Considering we are at the lowest interest rates in 37 years and most analysts expecting the next move to be up, in simplistic terms, this won’t bode well for a bond holder needing cash after an interest rate increase.
All said and done, RSBs are a very worthy option in the right circumstances. If you are unsure, however, make contact with a CFP® professional in your area to discuss how this would apply to your personal circumstances and what other options might be considered.
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