For those who are not prepared to risk their capital to try and achieve higher returns, the ability to rely on traditional savings products has never been more challenging. Savers keen to maximise the level of FSCS protection with their capital have only really had a couple of options historically. Either accept a variable rate but have instant access to your savings, or alternatively sacrifice access and receive a higher interest rate depending on how long you are able to tie up your money.
But as savers continue to face significant falls in the level of income available, more and more of us are having to face the truth about just how serious the situation is. So what are you doing with your savings and have you questioned your decisions in the past? Here we take a look at the harsh reality being faced by savers whilst looking at the pros and cons of the options being considered. Our Head of Savings and Investments, Oliver Roylance-Smith, will also offer his own view in the context of the current savings rates on offer and the outlook for the market in the coming years.
‘Tis the season to be jolly…
Unfortunately the start of advent has not brought with it any gifts for savers. Although the plight of savings rates often takes a back seat to the more economically charged debate around when we might see a rise in interest rates, the ongoing situation for savers is a fairly easy one to square off.
The current Bank of England base rate of 0.5% is the lowest it has ever been, and with the Monetary Policy Committee (MPC) voting again this month to keep it on hold, we are now in the 68th consecutive month of this record low – that’s’ over 5 and half years… So if you’ve ever made a decision on your savings based on the hope that interest rates might go up within the next 12 months, you now have a constant reminder of how painful this can be.
Could savings rates get any worse?
While the base rate has remained unchanged, interest rates on best buys have crashed even further to shockingly low levels as a result of the government’s funding for lending scheme. The current savings rates environment has, therefore, created the most challenging of times for savers and compared to rates on offer five years ago or more, you would be right to think that things couldn’t get any worse, but could they? Perhaps more important is to consider when rates might start to improve?
Fixed rates
Fixed rate savings have been particularly uninspiring. Leading one year fixed rate bonds currently offer around 1.9%, three year fixed rates around 2.5% and up to 3% is on offer if you can fix for five years. Top deals a year ago would have secured you 2%, 2.55% and 3.15% over these same terms and so not only are the current best buys offering painfully low rates, but they are also even lower than they were 12 months ago. This means that millions of savers with fixed rate bonds maturing continue to face significant falls in the level of interest available when compared to the current rates available from the same length bond again. Many are looking at falls of up to 50%.
Fair Investment view: “A fixed rate bond pays a known rate of interest at set times for the term of the bond, which are the most appealing features of this type of product. However, rates are at an all time low and so the returns available will be much lower than fixed rates a few years back. Also remember that if you do tie yourself in now and inflation goes up, your real return (i.e. the return after inflation and tax) could be negative. The real question to ask might well be whether between 2% and 3% is enough for removing access to your capital?”
Instant access
The knock on effect of such low savings rates is that many have moved away from longer term fixed rates in favour of instant access accounts, where unfortunately rates are also at record lows and have been for some time. Leading instant access accounts are paying a paltry 1.50% AER and so all but non-taxpayers are losing money in real terms despite the headline rate of inflation standing at 1.3% and well below the Bank of England’s 2% target.
Fair Investment view: “The upside here is that you have instant access to all of your money, whenever you want it, although there are still some top deals where the headline rate includes a bonus after 12 months so you may still need to plan ahead. However, we are also well into our sixth year of record low interest rates and leading instant access accounts are only paying around 1.5%. With little to suggest this is going to change significantly any time soon, shoring up money here on the basis that interest rates will go up is potentially a very dangerous strategy indeed.”
Traditional savings rates failing to deliver
Instant access accounts and fixed rate bonds have been the mainstay of many a saver’s portfolio for decades. Instant access offers flexibility but normally with a variable rate of interest, whilst a fixed rate pays a set amount at a set time for a fixed term, offering a predictable income and usually a higher rate the longer you can commit your money for.
Unfortunately these two traditional savings products continue to suffer due to record low interest rates and a lack of desire by banks to attract your capital. It is also worth noting that just three years ago you could get 3.15% from an instant access account, a rate you can’t even get now if you are prepared to tie your money up for five years. So what else is there?
High interest current accounts
You might be able to secure a high headline return from a current account if you are prepared to move your day to day banking facilities. However, each account comes with their own terms and conditions such as having to pay money in, a limit on the account balance you receive this higher rate of interest on, or a high headline only lasting for a relatively short fixed term which then drops down to a lower rate – a tactic historically used by banks when trying to attract new money into their instant access accounts.
Fair Investment view: “The high headline will often look attractive but remember this is unlikely to be paid on all of the balance you hold in the account. On the basis that many will need to have your salary or pension paid into the account, you will also need to be prepared to move away from your existing bank account. However, for those able to meet the account criteria, these can be a good way to receive a high level of interest albeit on relatively small account balances.”
Structured deposits
Structured deposits are essentially a combination of a deposit and an investment product where the return is not guaranteed, but rather dependent on the performance of some underlying investment, normally the FTSE 100 Index, or a smaller number of FTSE 100 shares. While investing inevitably involves putting your capital at risk, the structured deposit offers the potential for higher returns but without risking your capital, thereby offering a middle ground for savers and the opportunity to enhance the overall returns from their capital.
They can also be used for both new Cash ISA money as well as Cash ISA transfers, and their deposit status means they are eligible for the Financial Services Compensation Scheme up to the normal deposit limits of £85,000 per person, per institution.
Fair investment view: “The main point to bear in mind is that the returns on structured deposits are not guaranteed and as such they are not designed to meet the entire needs of every saver. The trade off is the potential for higher returns and current plans are offering up to 7% each year. With the current market for all savings rates, regardless of term, offering very low returns by historical standards and the potential for inflation to rear its ugly head in the coming years, there could be a strong case to at least consider these as a complement to the more traditional fixed rate savings products.”
Time to face the truth – the facts
So let’s look at the facts:
- The Bank of England base rate remains at its 0.5% record low for the 68th consecutive month
- There is little to suggest the base rate will go up before the second half of next year with many economists saying it could well be 2016 before we see any change
- There is no guarantee that as and when a rise in the base rate occurs, this will also be passed on to saving’s rates
- Rates on instant access accounts are well under half the level you could have achieved three years ago when the rate was higher than those currently on offer from a 5 year fixed rate bond
- Many maturing fixed rate bondholders are facing falls in income of up to 50% when comparing the rates available now on a fixed rate bond with the same duration
Therefore, more and more savers still need to face the real truth about the impact this is having on their capital and their future, whilst making sure they understand the pros and cons of each option available.
The bottom line …
Ultimately, which option or blend of options will depend entirely on your individual circumstances however, these remain challenging times and traditional savings accounts are currently falling short of meeting the pressures put on saver’s capital by the continuing economic situation. With record low savings rates set to continue, at least in the short term, as a minimum we should make sure that all of the options available are weighed up very carefully indeed.
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No news, feature article or comment should be seen as a personal recommendation to invest. Prior to making any decision to invest, you should ensure that you are familiar with the risks associated with a particular investment. If you are at all unsure of the suitability of a particular investment, both in respect of its objectives and its risk profile, you should seek independent financial advice. Please note that tax treatment depends on legislation and your individual circumstances which may change in the future.
Structured deposit plans are capital protected. There is a risk that the company backing the plan or any company associated with the plan may be unable to repay your initial investment and any returns stated. In this event you may be entitled to compensation from the Financial Services Compensation Scheme (FSCS), depending on your individual circumstances. In addition, you may not get back the full amount of your initial investment if the plan is not held for the full term. The past performance of the FTSE 100 Index and any of it shares is not a guide to its future performance.
