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Rolling over NS&I Index-linked Savings Certificates

I recently had some NS&I [1]1 [2] Index-linked Savings Certificates approach maturity, after five years fighting inflation in an obscure corner of my portfolio.

Truthfully there was never much doubt I’d reinvest them into new certificates (or “roll them over”, in the parlance).

But I always try to have fresh eyes [3], and so I did entertain the idea of cashing them.

Indeed the deal for renewing was superficially lousy.

Whether I chose the three or five-year fixed term, I was offered a tax-free return of: “Index-linking2 [4] +0.01% per year”

A real3 [5] return of 0.01% a year?

Pitiful – below what every major asset classes in the UK has achieved over the long-term on a historical basis [6] and unlikely to excite a Warren Buffett wannabe.

Nevertheless I did roll over this tranche of certificates – and for five years, too.

Madness? Defeatist?

Here’s my thinking – and why if you can you should probably do the same.

Exotic investments for the everyday investor

An ex-girlfriend of mine used to rail against the millions spent on saving the panda from extinction. Such money would be better deployed, she said, conserving ecologically important beetles, sea slugs, and flatworms.

Pandas were needlessly exotic creatures with no useful role in today’s world.

And I have to admit, these Index-linked certificates can appear rather similar.

But in contrast to pandas, these certificates are much more attractive than they first appear.

For one thing – like pandas in my ex’s utopia – they’re not making them any more.

If you’ve got Index-linked certificates and they mature, then so far you’ve always been able to roll them over into new certificates.

But if you haven’t, then you can’t get them. NS&I has none for sale.

In fact, it last offered certificates for new investment (as I flagged [9]) back in 2011.

So already here’s a couple of things to think about.

Firstly, their lack of availability might imply the certificates are so attractive that NS&I has had to withdraw them from sale.

NS&I is the UK government’s state-owned bank. It walks the line between raising money to fund government borrowing whilst trying not to distort or overly out-compete the commercial market. And that is hard [10], especially given that no commercial bank can raise taxes or print money to meet its obligations.

The suspicion must be that demand for new Index-linked certificates in our risk-adverse and low-yielding times would be so great that it would overwhelm NS&I’s targets – even with that puny 0.01% interest rate.

This alone should give you pause before cashing them in.

But there’s a second and related factor.

The absence of new issues makes the certificates “use them or lose them” investments. You don’t have the flexibility to cash them in and put the money into the stock market, say, and then change your mind in a year and move back into new Index-linked certificates.

Like death or pursuing a career as a eunuch, cutting loose your certificates is a one-way operation.

And that’s a big decision to take.

The manifold attractions of NS&I Index-linked certificates

Of course, there are many assets that are hard or impossible to get hold of – but that doesn’t make them good investments.

Millennium Dome memorabilia, for example.

However NS&I’s Index-linked certificates boast big attractions beyond that tiddly 0.01% interest rate.

Specifically: Tax-free status, inflation-proofing, RPI-linkage, a guaranteed positive return, and the full protection of a State-backed product.

In my view, these benefits turn the certificates into must-keeps for most private investors lucky enough to own some in their well-diversified portfolios. There’s nothing else quite like them out there.

Let’s briefly consider each benefit in more detail.

Tax-free

You don’t pay any tax on your return from Index-linked certificates. You don’t have to declare it to HMRC or do any tedious paperwork [11].

Win, win, win.

Inflation-proofing

NS&I Index-linked certificates are lump sum investments, designed to be held for a specific length of time (or term).

If you keep your money invested for the whole term (i.e. you don’t cash out early) then your money is guaranteed to grow (minutely) ahead of inflation.

Each year the certificate’s value is raised in line with a specific index of inflation, called the Retail Price Index (RPI). If this index goes up at the anniversary of your investment, then so does the value of your certificates (hence Index-linked certificates).

The 0.01% interest rate? That’s just the titchy cherry on the cake.

In contrast, a normal savings account has no guaranteed inflation protection. A 2% interest rate on a cash savings account only delivers a real (after-inflation) return if it outpaces inflation.

If inflation is running at 2.5%, then your 2% cash savings account is losing you money in real terms.

RPI inflation-proofing

Following the 2010 General Election, the government announced it would phase out RPI in favour of the Consumer Price Index (CPI), most notably when it comes to pensions and benefits.

However for reasons unknown, NS&I has been able to stick with using the older RPI measure for these certificates.

This is important because CPI tends to be lower than RPI – partly because of the way it’s calculated, but also it’s claimed [12] because CPI ignores significant housing-related costs.

The percentage change in CPI over the past 12 months has been 0.3%, for example, while the same figure for RPI is 1.3%.

Now, everyone’s personal inflation rate is different – it depends how you spend your money.

If you send your kids to a private school and fees are rising 10% every year, then both CPI and RPI may look moot, compared to your sky-high personal inflation rate.

However there’s no product that will guarantee your capital’s spending power in terms of your own personal consumption of school fees, sexy smalls [13], or Apple products [14].

The best you can aim for is to see your capital up-rated by the highest widely-used measure of inflation possible, and most believe that is RPI.

As an aside, the Government has mooted [15] switching 130,000 pensions payable to current and former steelworkers from RPI to CPI in order to reduce Tata Steel UK’s £485m pension deficit – which would happen because future pension liabilities would be lower using the CPI regime.

That’s the flipside of the benefit you aim to get from your Index-linked certificates being tied to the higher RPI measure.

Guaranteed positive return

However you measure it – CPI’s 0.3% or RPI’s 1.3% –  inflation does not look frighteningly high right now.

And as I mentioned it’s been mired below the Bank of England’s official target of 2% for years.

The point of insurance though is to take it out before you need it – and these Index-linked certificates protect you from higher-than-expected inflation [16] as well as deflation like no other asset.

That’s because you’re guaranteed to get a real positive return from them, albeit only juiced by a 0.01% interest rate.4 [17]

What about index-linked gilts [18]? Aren’t they just as good?

Nope, the NS&I Index-linked certificates are superior.

Barely trumpeted in the certificate literature – but worth shouting from the rooftops – is the promise that “if the RPI goes down, the value of your investment is protected and will not go down.”

That’s a far better deal than you get with index-linked gilts, which offer no such protection and where a negative RPI (deflation) will entail capital losses.

What about cash [19]?

Cash is far less directly comparable [20], of course, but it’s worth stating the obvious – that while cash does hold its value in deflationary times (assuming you’re not being pummeled by negative interest rates) it doesn’t offer any inflation-protection, except in as much as the best interest rate you can get will often outpace inflation in practice.

(Historically [6] cash has delivered a real return of around 1% in the UK over the long-term, and you can probably do better if you’re nimble [21]).

So that’s the big attraction of Index-linked certificates. They are guaranteed to hold their value in either inflationary or deflationary times, although that tiny 0.01% interest rate might mean they do little better.

Government backed and guaranteed

The NS&I Index-linked certificates have the great benefit of HM Treasury standing behind them.

The British Government can print money to meet its obligations. Thus in the general sense of the term, the Index-linked certificates are 100% safe and secure.

If you and perhaps your partner have managed to amass a small fortune in Index-linked certificates over the years, this compares well to a High Street savings account, where the FSCS compensation scheme [22] only covers deposits of up to £75,000 per institution.5 [23]

True, you can spread cash between multiple institutions if you’ve more than £75,000 to squirrel away, and I’d recommend you do.

But owning NS&I products puts you one step closer to the source of such guarantees.

Of course there are always circumstances in which even this putative 100% backstop could go out the window. Every investment can fail you [24].

A popular revolution or a takeover of government by a tyrant might do it. Or more likely some nefarious sneak attack by a corrupt or desperate regime (such as introducing onerous and unavoidable holding fees, say, or dramatically fiddling the inflation measure).

But that sort of tail risk goes into the baked beans and shotgun corner of a portfolio. Most if not all other investments will also be up in the air in such circumstances.

In practical terms, NS&I Index-linked certificates are as safe as investing gets.

Penalty box: Cashing in early

A downside to Index-linked certificates is they lock your money away for several years. NS&I explicitly warns you to think about whether you might need to cash them in early, and thus whether they’re right for you.

It’s true you should almost always consider illiquidity as a negative in an investment.

However in practical terms, I don’t think it’s too much of an issue here, so long as you’ve got a cash emergency fund [25] salted away and the other basics of investing covered.

For starters, as we’ve discussed they’re not issuing new Index-linked certificates any more, so there’s not going to be any fleet-footed rate-tarting going on. If you’ve decided you want them, you’re probably going to want to keep them. You’ll not be ducking in and out like you might with Best Buy cash accounts.

Secondly, you can get out early – this is not one of those investments that truly locks up your money up for the period and swallows the key.

There is a penalty for cashing out ahead of time, but I don’t think it amounts to much – unless you’re forced to fold when you don’t really want to.

Cash in the certificates early and you’ll pay a penalty equivalent to 90 days’ interest on the amount you raise.

Remember though, the interest rate is only 0.01%! You’re going to need your reading glasses to work out what 90 days worth of penalty at that rate will amount to. (Clue: It’ll be trivial).

More meaningfully, you will also lose the index-linking on your whole Certificate for that investment year.

This is significant; it could amount to a few percentage points of return foregone in a big year for inflation.

But in practice it just means you should be careful to only cash in at the start of a new investment year, rather than a few months into one (and certainly not in the 11th month!)

Personally, I decided to renew my certificates for the full five-year term – as opposed to the shorter three-year option – following this very logic.

If something better appears after three years (perhaps from NS&I itself) then I can cash the certificates in a day or two after the start of the start of a new investment year and effectively pay no penalty.

It’s a portfolio, silly

You’ll notice I haven’t prattled on about the expected returns [26] of other asset classes as a comparison – except to say that historically all the big guns have done better than the 0.01% per year real return you’ll expect from these Index-linked certificates.

And that’s because it’s not really the point.

We know these Index-linked certificates will hold their value over the next five years. That’s not true of any other asset class.

Cash could conceivably suffer through flat to negative interest rates. Shares and even bonds could do almost anything [27] if markets get really bad. It’s true you can bag a known nominal return from UK government bonds if you buy them individually, but neither you nor I know what inflation will do over the next five years, and that could crush their returns in real terms.

Of course, “holding their value” is hardly the stuff of investing daydreams.

In fact a quick calculation reveals the tranche of Index-linked certificates that prompted this piece have delivered a 2.8% nominal return over the last five years.

My wider naughtily active [28] portfolio delivered a far higher return than that.

However a good portfolio is much more than the sum of its parts. There’s more to it than looking at a poor performer – or even one you expect will most likely perform relatively poorly – and deciding to lop it out. It’s how the portfolio works in concert that matters. How it combines with your investing strategy to hold together in all-weathers [29].

Something will always be disappointing you in a well-diversified portfolio. If these Index-linked certificates turn out to be the weakest performers over the next five years, then hurrah – because it will mean my vastly larger allocation to equities, for example, will have done better!

True, if I had a massive slug of these certificates then perhaps I’d need to think more carefully about how much money I wanted to commit to merely keeping up with inflation.

But like most people I only have a few percent in them, and as we’ve discussed they’re not making them anymore.

A solid hold, then. If only all investing decisions were this easy.

  1. National Savings and Investments [ [32]]
  2. That is, a return that keeps the value of your investment unchanged in real terms after a particular measure of inflation. [ [33]]
  3. That is, inflation adjusted. [ [34]]
  4. You got a 1% interest rate from the certificates in 2009, and a tub-thumping 1.35% a few years before that. [ [35]]
  5. Or up to £1 million for certain temporary high balances, such as when you’re buying a house. [ [36]]