Merryn's Blog

The best way savers can beat inflation

If you want more interest than you'll get in a savings account and you are prepared to take some risk, look at some of the retail bonds coming to the market. A particularly attractive one comes from National Grid.

It used to that you could still protect £15,000 of your cash from the combined effects of tax and inflation by shovelling it into a NS&I index-linked bond. But now you can't do that anymore they were withdrawn last week. And there isn't much you can do instead.

We look at some of the alternatives in this week's magazine out tomorrow but the truth is that if you want to be absolutely certain you will get your money back, you need to be in a bank covered by the UK's deposit guarantee. And none of those banks offer accounts that will allow you to maintain the real value of your savings.

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Put your money in a savings account, and you guarantee the slow erosion of your wealth. On the plus side, at least it will be only a slow erosion: given the global macro economic environment, you might find that if you put your money anywhere else the erosion will be significantly faster.

But what if you want or need to make a higher income and you are prepared to take some risk? Then you might want to look at some of the retail bonds coming to the market.

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There have been a few this year (including those from Caxton FX, Tesco and John Lewis) but yesterday brought news of one from National Grid that comes with something a little special - at least to those still traumatised by the news that UK CPI has now hit 4.5% - the returns from which will indexed to inflation.

The bonds will pay a starting interest rate of 1.25%. That's not much, but it rises in line with inflation. However, the key point and where the value in the bond lies - is that over the ten years the capital value of the bond rises in line with inflation. So in ten years the money you get back will have the same inflation-adjusted value as the money you put in. And you'll get a little income along the way.

Most corporate bonds work differently. They pay a higher initial level of interest, but they only redeem at par (put in £100 and you get £100 back ten years later) so their capital value is generally destroyed by inflation.

Finally, note that if we see deflation over the next ten years rather than inflation, holders of these bonds will still do well: there is a floor of par value, so even if inflation is negative, if you put in £100 you will still get back £100.

All this doesn't make the bonds anything near a substitute for the NS&I product: if you want out during the ten year period you will have to sell them in the secondary market, in which case you might not get back your original capital; it isn't tax free; and of course it isn't government backed.

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However, what it does do is effectively guarantee a real return if you buy the bond at launch, put it in an ISA and hold it for ten years - subject of course to the National Grid not going bust (see page 12 in the prospectus here for the "substantial risks" involved in this assumption). You can't get that in many places.

You can read the full terms of the bond here. and you can buy the bonds subject to a minimum of £2,000 through stockbrokers until 29 September (although if demand is high, the issue couldclose earlier). I'm considering some for my SIPP.

Those who can stomach a little more risk might also look to National Grid's shares: they are currently paying a dividend of 5.5%.

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