S.Africa: Beating the inflation monster - for conservative investors

[I never knew that these bonds were linked to inflation. The bond issues by our worthless Govt have however in recent years been big flops. Nevertheless, if it is truly above inflation, it might be of interest to some folks since there are so few investment alternatives for South Africans. Jan]

There is arguably only one investment product that guarantees to increase your wealth: an inflation-linked bond. Other investments, such as shares, property, cash and bonds offer no guarantee that they will beat inflation (although the longer you stay invested in the first two, the more likely that outcome becomes).

At present, your money needs to grow at about 10% a year just to keep up with general price increases.

You could invest in various commodities such as wheat, maize, oil, copper, gold etc, but this would only help you keep up with inflation, not beat it.

Investment professionals will tell you that shares and property are very likely to beat inflation over time. But if you're an ultra-conservative investor, inflation-linked bonds probably offer the most secure guarantee of a real return.

These products were recently offered to the layperson through Treasury's retail bond initiative. The initiative allows investment in government bonds for as little as R1 000 through any post office or Pick n Pay (for registered investors). There are no fees or commissions.

An inflation-linked bond issued by Treasury is essentially a promise by government to increase the value of your investment at a pace greater than the rate of inflation. This rate of inflation is measured by the Consumer Price Index, which is calculated by Statistics South Africa.

The CPI measures the rate at which a basket of goods consumed by the average South African increases in price.

The money you invest in an inflation-linked bond is adjusted for inflation over the life of the bond. On top of this you earn interest payments, which are paid every six months and are based on the inflation-adjusted investment value.

The bonds offered by Treasury promise interest payments of between 2,75% and 3,25% a year, depending on their maturity.

Three-year bonds pay 3,25%, five-year bonds pay 3% and ten-year bonds pay 2,75%.

This shows that investors are prepared to accept a lower return for a longer period of inflation-beating returns.

The yields offered by inflation linked bonds are not particularly attractive when compared to historical prices. Only a few years ago, the real returns offered by inflation-linked bonds were double what they are today. And if the past 100-odd years is anything to go by, you can expect an inflation-adjusted return of about 6% from South African shares.

When you buy an inflation linked bond, you have no idea how much interest you will receive or what your investment will be worth on maturity. This contrasts with normal bonds, where these figures are usually certain.

All you can be certain of is that your investment will outpace CPI by the rate you are quoted when you buy the bond.

As with any investment there are risks to inflation-linked bonds. The risk of government defaulting on its debt is considered to be extremely low, but it is not impossible.

Greater risks lie in the calculation of inflation. There is no guarantee that Stats SA will do this correctly, and there has been some controversy in the past.

For more information on Treasury's inflation linked bonds, see www.treasury.gov.za or www.rsaretailbonds.gov.za. Or call 012 315 5888.

Source Url: http://www.moneyweb.co.za/mw/view/mw/en/page66?oid=205438&sn=Detail

Posted By: Jan
AfricanCrisis Webmaster
Author of: Government by Deception