Index linking can protect investments from inflation
Investments – such as deposit accounts, bonds and pensions – can include measures to take account of inflation and preserve spending power. One way to do this is “index-linking”. The eZonomics story What is … index-linking? explains in detail. Index-linking is particularly topical at the moment because high food and petrol prices are pushing up inflation in many countries. As the eZonomics video How to protect your savings from inflation explains, it is important to pay attention to inflation as rising prices eat away at the spending power of money over time.
Investors can weigh up how fast the index is likely to rise
A common form of index-linking ensures investment income increases at the same rate as inflation. A savings certificate, for example, might pay 1% a year plus an extra amount to match the speed at which inflation has gone up. Because of these inflation-related payments, index-linked investments typically have a basic rate of interest that is lower than that on an ordinary investment. When deciding whether to use an inflation-related, index-linked product, investors weigh up how fast they think inflation is likely to rise and how much risk they want to take. If the inflation rate slows or turns negative, then returns on linked investments typically drop. Index-linked investments are not always linked to inflation. Another example is investments linked to stock market indices.