Index-Linked Bond

Inflation is a risk for bond investors. Since the interest rates on many bonds are fixed for long periods of time (you buy a 10-year bond with a fixed 5% interest rate), a significant rise in inflation can seriously cut into the real value of the return.

You have a long-term bond with a 5% return. This investment provides much more value in terms of additional spending power earned when inflation is 1% than when inflation is 3%. The faster rise in prices means the money you're earning buys less.

Also, higher inflation forces bond sellers to increase the rates they offer. If you didn't have your money tied up in that stupid 5% bond, you might be able to find a 7% with a similar risk profile.

An index-linked bond provides some protection against inflation spikes. These debt securities have interest rates tied to some index, usually one tracking inflation. The Consumer Price Index is a popular choice. When the CPI rises significantly, the interest rate for the bond rises along with it. Tying the interest rate to a measure of inflation guarantees the investor a minimum real return.