In my previous article, “Get to know the basics of Government Bonds,” I talked about the basic concepts behind bonds. I will be using some of those concepts in today’s article.
Today I’ll be extending my discussion on bonds and talking about inflation-linked bonds. But before I do that, let me discuss the concept of inflation and its relevance to your money.
What is inflation?
Inflation is the increase in general prices of services and goods over a period of time. A good example of inflation in action is the general increase in the price of bread over time. In the past, the price of a loaf of bread was R7. Today, however, because of the effects of inflation, the price has increased to roughly R14.
The points about inflation that you should keep in mind are that:
- inflation can’t be stopped or avoided and
- money that is not earning interest, either through saving or investing, is losing its value and buying power. An example of this is money that is tucked away under a mattress. It loses value at the rate that inflation is increasing.
Let’s get into it
The South African Government, through the National Treasury of the Republic of South Africa, issues bonds in order to raise funds. The Treasury issues two types of bonds: fixed interest rate bonds and inflation-linked bonds. Our focus will be on inflation-linked bonds.
Why inflation-linked bonds in particular?
What makes inflation-linked bonds special is a simple: they are inflation-adjusted over time. This means that money invested in these bonds grows at a rate that is determined by the rate of inflation. This protects the value and the purchasing power of your money.
For example, if inflation causes the price of a loaf of bread to increase by a certain percentage, then these bonds will adjust the value of your money for this increase. (Your R10 will grow so that you can buy a loaf of bread, even if it is now worth R14, if you have invested it in these bonds).
Will I get the same inflation-adjustments with non-inflation-linked bonds?
No. The above is not necessarily true for non-inflation linked bonds. In other kinds of bonds, the value of your money will be eroded by inflation if it grows slower at a rate that is less than inflation.
Other things you should know about inflation-linked bonds
There are several other characteristics about inflation-linked bonds that you should know. Here are some:
1. The Treasury-issued bonds come with maturities of 3 years, 5 years and 10 years. The coupon payments will be paid twice a year (every six months). Unlike other types of investments, however, there is no option to reinvest these interest payments when they are paid out.
2. The inflation rate used will be that of the Consumer Price Index (CPI), which is published monthly by Statistics South Africa. The inflation rate at the time of your investment will be the one used as the frame of reference to adjust all future payments should the inflation rate change. The base rate is the official term used to refer to the inflation rate at the time of your investment.
3. An investor can only withdraw funds twelve months after the settlement date (the actual day when the bonds are transferred into your name), unless an extraordinary change in personal circumstances occurs. In such a circumstance, the investor will be penalized an amount equal to one interest payment on the early withdrawal amount.
4. All citizens or permanent residents of the Republic of South Africa are eligible to purchase the bond, while persons under the age of eighteen must receive parental or legal guardian consent, unless they are married.
5. The minimum purchase of a bond is R1000 (one thousand rand), while the maximum is R1 000 000 (one million rand). The inflation linked bond is available at any branch of the South African Post Office, the RSA Retail Savings Bond website, at the National Treasury, or through their contact number (012 315 5888). Payment can be made at any branch of Pick ‘n Pay, Boxer, or Score. It can also be made at any branch of the South African Post Office, through internet banking, or direct deposit at the bank.
6. In order to acquire the bond, an investor needs a valid South African Identity Number (driver’s license or passport numbers are not acceptable) as well as the latest certified copy of your ID, personal banking details – bank name, branch name and code, account type and account number – and the most recent (up to three months) bank statement as proof of bank details, income tax number (if applicable), provable residential details, and contact details.
In this article, I hope I have provided relevant information regarding inflation-linked bonds. In the next article in the series of government bonds, I’ll be making the case of why a person should consider buying inflation-linked bonds, as well as the opportunity cost associated with buying these bonds.
This article was written by Liso Mdutyana.
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