Index linked isa

Sandra_Ellis_2

I have looked at the National Counties new index linked ISA and it seems to be very confusing. The basis of the indexation is quoted as -

"# Illustrative rate using the change in the!Retail Price Index (RPI) between July 2005 and July 2010 as per Office of National Statistics, July 2010.! Should there be no change to the RPI!over the five years, only the fixed rate interest of 1.00% pa tax-free^ will be earned. The RPI!can fall as well as rise and past performance is not a guide to future performance."

This means that ONLY the difference in RPI at the start to the end will be earned over the whole 5 years. I rang to check if my understanding was correct and a representative agreed.

Biggles

That seems very straightforward, and is how I assumed it should work. What were you expecting?

smallfry27

Already discussed here

https://forums.moneysavingexpert.com/discussion/2664857

and here

https://forums.moneysavingexpert.com/discussion/2665559

xrjtg

Here's an over-simplification that may or may not help some people understand index linking.

At some point in the dim and distant past the powers that be assembled what they considered to be a representative basket of goods, researched a typical market value for it, and decreed that the basket cost 100 points. This points value is known as the index.

The next year they went out again and researched the then current market value of the same basket of goods. They discovered that it cost 2% more than the previous year, and declared that the index had risen to 102.

The next year prices rose another 2%, taking the index to 104.04. This continued for a total of 5 years, after which the index had reached 110.41.

At the start of the 5 years, an institution wanting to sell people protection against the effects of price rises offered a savings account with index-linking. This meant that at the end of the 5 years, every £100 deposited had risen in value to £110.41.

In this toy example the index isn't doing a lot of work: it would be easy to compound the 2% directly. But in real life prices don't vary at such an even rate; the increase might speed up, slow down, or even go into reverse. This is the value of the index: it screens off the ups and downs over the 5 years, allowing you to read off the exact change in prices without adding up all the various inflation figures published over that time.

For an account that offers index-linking and a fixed rate of interest on top, the interest is calculated as normal, then an extra increase applied that mimics the change in the index over the life of the account. The monthly or other inflation figures published in that time don't get any consideration.

Jonbvn

OP I believe you are thinking that if there is no change in the annual percentage inflation rate, then you will only get the 1% per annum. That is not correct. What matters is the change in the RPI expressed as a percentage. The chances of this being zero or less are very unlikely.

Sceptic001

Sandra_Ellis wrote: »

This means that ONLY the difference in RPI at the start to the end will be earned over the whole 5 years. I rang to check if my understanding was correct and a representative agreed.

Yes, but the important point is that RPI stands for Retail Prices Index. It is not the same as the annual rate of inflation. If the RPI starts at 100 and the annual rate of inflation is a constant 5% for 5 years, the RPI after 5 years will be 127.6. Only if there is no overall change in 5 years will RPI remain at 100 - Highly unlikely as Jonbvn says.