previous post detailed why I like them however I wanted to learn a little more about them given my large holdings. A web search turned up very little so I have had to do some analysis of my own. I have followed a similar style of analysis to that of all the asset classes I invest in or someday would like to invest in (these can all be seen in the right hand side bar under Latest Charts) that I regularly post about however because of their complexity the analysis is not perfect but in my opinion more of a trend.
Firstly though some basics about how the returns are generated as I understand them:
- Index-linked Savings Certificates are meant to be held for a fixed term. Returns are therefore added on the anniversary of each purchase only.
- They provide protection against inflation (the Retail Prices Index – RPI) with guaranteed interest on top. The RPI part is calculated by taking the index at the start and end of each investment year only. If this is positive then it’s added to the anniversary interest rate. If it’s negative then no RPI adjustment is made.
- To get the full rate of interest you must hold the certificates for the full term. For example the current 3 year 20th issue pays RPI+0.85% of purchase price for year 1, RPI+0.95% of 1st anniversary value for year 2 and RPI+1.21% of 2nd anniversary value for year 3.
- If you keep then less than a year you earn neither RPI nor any interest.
I must however say that if you’re going to consider buying Index Linked Savings Certificates then please read the Terms and Conditions (which are 3,470 words long) carefully. Why do all investments have to be complicated?
The table above details the previous historical issues for 3 and 5 year Index Linked Savings Certificates dating back to 1992. This gives me some useful data including:
- The average return for 5 year certificates since 1992 has been the retail prices index (RPI) + 1.5%.
- The average return for 3 year certificates since 2003 has been the RPI + 0.94%. This makes the RPI + 1% that I have just bought here seem reasonable.
- The frequency of new issues of 5 year index linked savings certificates since 1992 has been on average every 154 days although the periods have been as short as 16 days and as long as 493 days.
- The frequency of new issues of 3 year certificates since 2003 has been on average every 130 days although the periods have been as short as 28 days and as long as 400 days.
- You cannot always count on 3 and 5 year index linked savings certificates being released together.
My chart today is an attempt to assess whether over the longer term Index Linked Savings Certificates are a better bet than cash. The red and blue lines show approximately the real (after inflation) return of the Index Linked Savings Certificates. This is not adjusted for tax as no tax is paid on the certificates. The olive line shows the approximate real return of a typical cash investment. This is calculated by taking the cash return and then subtracting tax at 40% (as I’m a 40% tax payer) and then subtracting inflation. It shows that for me it is extremely difficult to get a real return on cash with one being achieved in only 23 of the last 73 months. The index linked savings certificates in contrast will always give me a real return.
Note that I’m sure that this chart is not perfect for many reasons with some reasons being:
- The certificates annual return shown is only achieved by holding for the full term and should the RPI go negative the real return would actually be higher than that shown.
- The certificates real annual return is considered as the headline return available on the day for a new 3 or 5 year investment period ignoring the RPI adjustment.
- In contrast the cash annual return is considered as the monthly average of UK resident banks sterling weighted average interest rates for new time deposits with a fixed original maturity of >2 years from households not seasonally adjusted. I have then subtracted the RPI percentage for each month.
The last month has really shown the benefits over cash for me. My cash investments have shown an after tax return of 0.1%, my index linked savings certificates a return of 0.76% (using the calculator on the NS&I website) compared with an increase in inflation of 0.68%. Of course the certificates return is an estimate only as I’m not cashing in and so interest and any index linking for the year are only added on each anniversary of the Certificate. However they seem to be doing exactly what I hoped they would – protecting the low risk portion of my low charge portfolio from the ravages of inflation.
As always I’d like to encourage any comments. For example, what do you think of Index Linked Savings Certificates, what have I misunderstood / missed when assessing these things or do you invest in these certificates.
Of course as always do you own research.