The current crop of options for those considering fixed rates for their savings is not looking great, particularly those with a term of 3 years+. With this in mind, we take a look at the wide range of alternative options available to savers, all of which offer full capital protection but with the potential for higher returns.
Where have all the high streets rates gone?
Many of the high street names involved in the fixed rate bond and Cash ISA markets are taking a breather on the back of cheap funding available from the government’s ‘Funding for Lending’ scheme, run by the Bank of England.
The knock on impact of this recent initiative is the creation of a huge void in the fixed rate market with fewer and fewer deals available each week. Unfortunately, this does not help the constant need for savers to find a competitive deal since we must take action if our fixed rate matures or an introductory bonus comes to an end. The effect of waiting, even for a short period, can have a significant effect on our overall return.
Although inflation dropped last month with the Consumer Price Index (CPI) falling 0.3% to 2.2% and the Retail Price Index (RPI) also falling 0.3% to 2.6%, according to the Office for National Statistics the figures for October are not so healthy with the CPI rising to 2.7% and RPI up to 3.2%. The ebb and flow of inflation and the disconnect between the stated headline yield and what many of us are actually experiencing makes it extremely difficult for savers to stay on top.
Certainly those who rely most on their savings to supplement their income or simply to provide a net return after tax and inflation are being hit hard by the lack of competitive fixed rates, especially in the medium to long term. This is putting even greater pressure on savers to take a long hard look at how they split their money.
Short term rates as good as it gets
For shorter term money, instant access, notice accounts and fixed rates still offer a relatively wide choice of options. Instant access can bring you 2.50% AER, notice accounts 2.78% AER and fixed rates of 2.85% AER if you can commit for 2 years. Although these rates may at first glance seem reasonable the reality is that after tax, all of these accounts lose you money in real terms and if you’re looking to keep pace with RPI, this loss is by some margin.
For example, to keep pace with the current rate of RPI every tax payer requires a minimum of 4% each year just to stand still. Therefore, even at 2.85% fixed for 2 years, this is costing you well over 1% each year and even if inflation comes down, you are likely to be losing money in real terms – very costly indeed...
Fixed rates underperforming
Looking beyond this timeframe and the options start to look even less competitive. In the medium term, the benchmark for comparison purposes is our current leading 3 year fixed rate, which is 2.95% AER provided by United Bank Limited.
Over the longer term, there is even less on offer with anything over 3.50% AER being considered a competitive deal. Even with this slight uplift in rate based on the fact that you are committing your savings for the longer term, your deposit will still lose you money in real terms and falls short of providing the ever-important hedge against inflation.
Without a doubt, fixed rate bonds are an important part of the savings jigsaw, but their status as being the only option should be carefully considered in light of the economic reality that continues to affect every saver in the UK. The spotlight really intensifies when comparing short term fixed rates with medium and longer term options as it becomes clear the uplift in rate by tying up your money for longer is questionable.
These challenging economic conditions and poor fixed rates make it easy to understand why the opportunity to generate higher returns is a compelling one. The need for every saver in the UK to generated competitive returns, ideally over and above inflation, is now greater than ever and combined with the continued ebb and flow of inflationary pressures have created a continued growth of interest in the structured deposit.
When looking at viable alternatives, the starting point for savers is of course to protect their initial capital, which is why all of the options below are fully capital protected. These products combine capital protection with the potential to receive higher rates than available from fixed rate bonds and which also have the potential to beat inflation but without putting your capital at risk.
The returns on most are dependent on the stock market rather than being fixed and as the most widely recognised index in the UK, the FTSE 100 is commonly used. By linking your return to the stockmarket and thereby sacrificing a fixed rate, you create the opportunity to receive higher returns. The downside is that if the index does not perform in the way required to produce the stated returns, unless there is a minimum return you will only receive a return of your capital.
Market round up
The range of options covers those looking for income or growth and they generally range from 3 years to 6 years in term although some have the ability to mature early. They are usually available as Cash-ISAs and are eligible for the Financial Services Compensation Scheme which covers claims up to £85,000 per individual, per institution.
For those looking for income, Societe Generale’s UK Range 7 Plan offers the opportunity for an attractive 7% (gross) for each year the FTSE stays between an upper and lower range based on its level at the start of the plan. This range increases each year, starting at +/- 15% in year 1, and then increasing by +/- 5% thereby providing a wider range each year within which the FTSE can move. If it moves outside the range, the income is not paid for that year.
Investec’s 3 Year Deposit Plan offers a fixed return of 13.5% if the value of the FTSE at the end of the term is higher than its starting value, subject to averaging. This equates to around 4.31% compound and compared to our current leading 3 year fixed rate, offers the potential for a 1.36% annual premium.
Cater Allen offer a 3¾ year Growth Plan which will return 100% of any rise in the FTSE 100 over the term, capped at 26% (gross). Depending on your view of the FTSE this also offers the opportunity to provide a higher return than would be available through current fixed rates of similar duration.
The ability to mature early is a feature which is unique to structured products. Investec’s Kick Out Deposit Plan offers a potential 4.50% per annum (not compounded) with the opportunity to mature early provided the value of the FTSE 100 at the end of each year (from year 2 onwards) is higher than its value at the start of the plan.
This means a return of 9% could be yours after just 2 years and even if the plan runs for the full 5 years and then kicks out, this deposit offers the potential for more than a 1% premium on longer term fixed rates.
Growth – longer term, wider choice
Two further plans link your return to any upside in the FTSE 100. Legal & General’s Growth Deposit Plan offers 100% of any rise over a 6 year term, capped at 40% but with a minimum return of 4.85%, whilst Investec’s Deposit Growth Plan offers 115% of any rise over a 5 year term, without any cap.
Finally, Cater Allen’s Enhanced Growth Plan offers 150% of any rise in the FTSE, capped at 50% over the 6 year term whilst Legal & General’s Annual Bonus Deposit Bond offers an annual payment of 4.60% for each year the FTSE finishes above the starting value of the plan. Again, depending on your views of the FTSE, these plans could offer an attractive addition to your savings options.
Since the returns are not guaranteed these alternatives are not designed to meet the entire needs of every saver. However, what they do is provide a defined return over a defined tthe other options currently on offer within the market.
As with any savings product, there is always a trade off for receiving a higher rate of return and with structured deposits, this is made absolutely clear at the outset. The two main downsides are that the deposit taker may go into liquidation (as with any deposit) and that the payout mechanism within the plan does not occur so you only receive your capital back.
This has to be balanced and compared to the upside which is inevitably a greater return than could be achieved by putting you money away for the same length of time with a similarly rated credit institution.
The bottom line …
With the current market for medium and longer term fixed rates offering very little by historical standards and inflation continuing to cause a headache with our net returns, being well informed before committing to act has never been more important.
Taking into account that all of the turmoil that has caused this precarious financial situation looks set to continue for years to come, there would seem to be a strong case to at least consider these alternatives as a compliment to the more traditional fixed rate savings.
Compare alternatives to fixed rate bonds »
No news, feature article or comment should be seen as a personal recommendation to invest. If you are in any doubt as to the suitability of a particular investment you should seek independent financial advice.
These are structured deposit plans that 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.
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