moneyFYI
Financial Freedom Is Merely Organized Common Sense
Real Return Bonds
The government is acting to remove their variable rate financing. It is much like you changing to a fixed-rate mortgage.
In early November 2022, the government announced it would no longer sell Real Return Bonds. (RRB) They were never something the average investor bought, so there was little notice. Until recently, who paid attention to inflation? People should have noticed. RRBs are valuable for two reasons.
- RRBs help you maintain purchasing power.
- If all government debt was in the RRB form, governments would work harder to avoid inflation.
How a real return bond works
Suppose you buy a $10,000 RRB when The CPI is some amount like 220. The interest rate specified is 2%. Assume interest is paid twice a year. You expect $100 every six months.
RRBs invariably pay less than a fixed-rate bond issued for the same maturity.
Six months later, the CPI index is up 3% to 226.6. You receive interest of 1% of $10,000*226.6/220, which is $103, and the bond is now $10,300.
As an investment.
When issued, the RRB will have a coupon rate lower than bonds without inflation adjustment. They are priced based on anticipated inflation. They work better for you if inflation is much higher than expected. They work for the issuer if the inflation is lower than expected.
In times of high inflation RRBs will demand too much cash disbursement compared to a fixed-rate bond issued at the same time. That’s why the government has stopped issuing them. Like you, they expect rates to go higher because of inflation and so change from variable to fixed rates. The government is the most significant contributor to inflation, so we can use that information to estimate the future with some accuracy. They expect more inflation.
You might be able to find one in the market that was issued earlier. The bonds are not very liquid, so you might have to wait to find one.
Taxation is more complicated too, so you should see them as useful in a Tax-Free Savings Account.
Of interest
The government has clearly indicated they expect inflation to be above the 1% to 2% range for the short to intermediate term. Maybe in the long run. When someone who knows tells you something against their interest, notice and act on the information.
I build strategic, fact-based estate and income plans. The plans identify alternate and effective ways to achieve spending and estate distribution goals.
Be in touch at 705-927-4770 or by email at don.shaughnessy@gmail.com.
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