Recent weeks have provided confirmation of the interest rate status quo from the Bank of England along with the release of the latest inflation figures from the Office for National Statistics. Combined, this still leaves us with more questions than answers in terms of what to do with our savings and investments.
To help, we have put together a range of options depending on your views as to what might happen in the future and your appetite for risk. Most importantly we also examine the pros and cons of each course of action.
The latest inflation figures showed a reduction in the Retail Price Index from 5.2% to 4.8% and the Consumer Price Index dropped from 4.8% to 4.2%. Short term reductions are generally expected and if we are to believe the Bank of England, this could drop below its 2% target by the end of the year, although they do not have the greatest record when it comes to inflationary forecasts and there is growing uncertainty within the committee itself around this central projection.
Perhaps more worrying still is that there is little discussion let alone agreement on what will happen should we dare to look beyond this year, which is clearly a very important consideration for those looking to put their money away for more than 12 months.
Short term options
Scottish Widows Bank’s Direct Transfer Account will provide you with instant access and an interest rate of 2.8%, which includes a 0.89% bonus paid for the first 12 months. As you would expect from an instant access account, the interest rate falls far short of inflation and the bonus falls away after the first year, however this could be an option for those who do not have a firm view on where inflation will go and so would prefer to wait and see what happens.
For those who are prepared to tie their money up for one year then you can achieve a slightly higher rate with FirstSave’s 1 Year Fixed Rate bond paying 3.45% but should inflation take a sudden turn for the worse, you will face penalties for early withdrawal.
Medium Term options
Scottish Widows Bank has recently launched a 3 Year Fixed Term Deposit Account paying 4% per year, with annual, quarterly or monthly payment options. Again, this rate falls short of the current headline rate of inflation but may be an option for those who consider inflation will fall in the short term and will not rise again in the medium term. To match the interest rate paid net of tax, inflation would have to fall to at least 3.2% otherwise you will be losing money in real terms.
In recent years the fixed rate bond has for many become the default for their savings. However, the last couple of years have seen persistent pressure on fixed rates with continued low interest rates and when compared to inflation, have given rise to a serious consideration of alternatives.
Most of these alternatives have a fixed term of at least five years but Investec’s 3 Year Deposit Plan is a medium term option. The plan pays out a fixed return of 19% after three years if the final level of the FTSE 100 Index is higher than the starting level. The final level is subject to averaging and in the event that it is lower you will only receive back your capital which is protected by Investec. However, the reward if the plan pays out is equivalent to nearly 6% per year compound - almost 2% higher than the 3 year fixed term deposit offered by Scottish Widows - and will beat the current level of inflation by quite a margin, even after tax.
Longer term options
For those looking to save or invest for the longer term (5 years+), there is a much wider range of options available. A benchmark for comparison purposes is a market leading 5 year fixed rate such as the 5 Year Fixed Term Deposit Account provided by Scottish Widows Bank, currently paying 4.6%. If you are a non-taxpayer, this rate is currently higher than the prevailing rate of inflation but for all other savers, inflation would have to drop to just under 3.7% for you to be keeping pace. Therefore, this could be an option for those who consider inflation will come down further in the short term and stay low for the longer term.
There have been a handful of plans which combine capital protection with the ability to receive back any increase in inflation, which is usually measured here by the Retail Price Index (RPI). One example is Legal & General’s Inflation Protected Deposit Bond which will return any increase in RPI over the five year term and so could be an option for those who consider inflation will fall in the short term but could well rise again in the future and want to cover this possibility whatever happens (i.e. there is no cap on returns). The plan also includes a minimum return of 16% should inflation fall and remain low.
If you are looking to beat inflation, especially after taking into account tax and any charges, there are a number of options to choose from. We will take a look at both income and growth options for those who either want to protect their capital or who are prepared to put their capital at risk in order to achieve higher returns which also offer the potential to beat inflation.
If you are looking for a high level of income without putting your capital at risk, Meteor’s Income Deposit Plan will pay an annual income of 7.5% for each year the FTSE 100 Index remains between 4,250 and 7,250 - yesterday’s closing level was 5,782 (23/01/2012). Capital protection is provided by the Royal Bank of Scotland and although the income is not guaranteed, the plan offers the potential to beat inflation depending on your views on what will happen to the FTSE in the coming years.
For those prepared to accept risk to their capital, Investec’s Bonus Income Plan is currently offering a fixed income of 7% per year with a potential bonus of 0.5% for each year the FTSE finishes higher than the starting level of the plan. Capital is at risk if the FTSE drops by more than 50% during the term of the plan (which based on yesterday’s (23/01/2012) closing price equates to 2,891) but even without the bonus, this level of income is currently inflation beating and a strong overall income investment.
For those wanting capital protection, Legal & General’s Growth Deposit Bond offers a return linked to any increase of the FTSE 100 over the 6 year term, capped at 50%, with a minimum return of 8% if the FTSE is lower or falls. Capital protection is provided by the Royal Bank of Scotland and although there is no guarantee that the FTSE will grow higher than inflation over the investment term, the plan offers the potential for high returns.
Finally, for those who are prepared to accept risk to their capital there is a range of Kick-Out plans available, which offer the opportunity to mature early each year if the FTSE 100 finishes higher than its value at the start of the plan. Investec’s Enhanced Kick-Out Plan offers the current market leading rate of 13.5% per year and can mature early after years 1, 2, 3 or 4 with a final year return equivalent to 120% of any rise in the FTSE with no upper limit. The potential for high returns, which are well above current levels of inflation, needs to be balanced against capital being at risk should the FTSE fall by more than 50% at any time throughout the 5 year investment term.
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.
Some structured investment plans are not capital protected and there may be the risk of losing some or all of your initial investment. There is also 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 which case you may not be entitled to compensation from the Financial Services Compensation Scheme (FSCS). In addition, you may not get back the full amount invested if the plan is not held for the full term. The past performance of the FTSE 100 Index is not a guide to its future performance.
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