Ideas for savers looking to enhance their returns
The pressure on savers to maximise the returns from their capital is arguably greater than ever before, but despite inflation coming down the current market for instant access and fixed rate bonds is providing less and less to shout about. We therefore take a look at a selection of opportunities that are being considered by savers looking for the potential to enhance their returns and with ISA season now upon us, this is a timely opportunity to consider our options carefully.
The new year has unfortunately seen a continuation of the all too familiar backdrop of economic challenges. The Bank of England base rate remains at 0.5% as it approaches its fifth year at this record low and although the headline rate of inflation has fallen to the Bank’s target rate of 2%, nobody is celebrating as we continue to face the difficulties in keeping our earnings or retirement income in line with the day to day cost of living.
All household incomes are under pressure and with a genuine fear and uncertainty around what could happen to inflation if one dares to look beyond this year, we should all be vigilant and wary of what lies around the corner, especially when considering what to do with our savings.
Savings rates, dire straits
The mainstay of many a saver’s portfolio has historically been the fixed rate bond. However, rates here have been under continued pressure as banks have been able to secure cheap funding by alternative means. This has resulted in a sustained fall in interest rates available and so long gone are the days where committing your money for longer was all you needed to secure a higher rate that also had the potential to outstrip inflation.
This has also resulted in a worrying trend of many savers shoring up reserves in instant access accounts. With leading deals only offering around 1.50% AER, the only guarantee here is that even with inflation at its 2% target you will lose money in real terms, and that’s before the impact of tax is taken into account.
Alternatives bridge the gap
This situation needs to be taken extremely seriously since it calls into question the traditional thinking behind saver’s decisions. Also gone are the days when it was enough to keep a relatively small amount in instant access and then simply roll your fixed rate bond into the prevailing rate available at maturity.
Although fixed rate bonds should continue to play an important part in the savings jigsaw, their status as being the only option for money we do not need immediate access to should be carefully considered in light of the economic reality that continues to affect every saver in the UK. With instant access losing money in real terms and fixed rate bonds not offering much of a premium for tying up your money, even if you think that inflation could average at the Bank’s 2% target for the rest of this year, it only takes a small increase and suddenly you could be facings significant loses in real terms. So what alternatives are being considered?
Where to start
Not only must we ask ourselves what it is exactly that we are buying when committing our capital to a fixed rate bond, we should also be considering what alternatives are available since the current market for savers often leads us to a tough decision – either lose money in real terms from a savings account, or take on more risk.
However, this does not necessarily mean that all of our capital needs to be exposed to risk since there is a wide range of alternatives to consider with varying levels of risk, and capital can be split across a number of options. Therefore, perhaps the most important consideration and one which should be considered first is whether you wish to expose any of your capital to risk or whether a return of at least your original deposit is your top priority.
For those who wish to protect their initial capital there are a number of viable alternatives to fixed rate bonds. As with other savings products, all of these plans are capital protected and eligible for FSCS protection.
For those with a shorter timeframe in mind, Investec Bank offer a 3 Year Deposit Plan with a potential 13% return at the end of the 3 years provided the FTSE 100 finishes higher than its starting value (subject to averaging).
Fair Investment view: The downside is the rate is not fixed and if the FTSE ends lower, you only get your initial capital back. The upside is that the potential return equates to around 3.51% per year compound after charges which offers a 1% annual premium on our current leading 3 year fixed rate bond. Click here for more information about the Investec 3 Year Deposit Plan »
Ability to mature early
For those prepared to tie in for the longer term but who would like the ability for their plan to mature early, the Kick Out Deposit plan from Investec offers the potential to mature from year 2 onwards. Provided the value of the FTSE 100 Index at the end of years 2, 3, 4 or 5 is higher than its value at the start of the plan (subject to averaging), even by just one point, then the plan will mature early and provide a return of 4.5% for each year (not compounded) – that’s a potential 9% in just 2 years. If the Index is lower on all of these dates, you will only receive a return of your initial deposit at the end of the six year term.
Fair Investment view: With leading fixed rate bonds only offering around 2.3% over two years and 3.25% if you fix for five years, the combination of capital protection and the potential for a higher rate offered by this deposit could be an option for those who are frustrated with low savings rates. However, if the Index is lower on all of these dates, you will only receive a return of your initial deposit. Click here for more information about the Investec Kick Out Deposit Plan »
The Deposit Kick Out from Gilliat combines the opportunity to mature early with the potential for a higher return of 7.5% for each year. Your return is dependent on the performance of five shares listed on the FTSE 100 Index with all five shares needing to be at or above their starting levels at the end of each year from year 2 onwards. If they are, you will receive your original capital back plus a 7.5% annual return (not compounded) but if one or more of the shares are lower at the end of every year, you will not receive any growth and only your capital back.
Fair Investment view: The potential for high returns, the opportunity to mature early and capital protection provided by Lloyds Bank plc could make a compelling alternative, balanced by the fact that these returns are not guaranteed. Click here for more information about the Gilliat Deposit Kick Out plan »
For those looking for growth and are prepared to tie their money up for the longer term, there are a number of opportunities to capture stock market linked returns whilst retaining full capital protection. For example, the Growth Deposit Bond from Legal & General will return 200% of any rise in the FTSE 100 at the end of the six year term (subject to averaging and a maximum return of 35% of your original investment).
Fair Investment view: If the FTSE rises significantly over the term you could more than double the leading fixed returns on offer but if it only goes up a little or falls, you would have been better off with a fixed rate. Either way, your capital is fully protected. Click here for more information about the Legal & General Growth Deposit Bond »
The UK Super Tracker Deposit Plan from Societe Generale offers a return of 4.15 times any growth in the FTSE over the term of the plan, subject to a maximum return of 41.5% plus a return of your capital. Therefore, if the FTSE rises by at least 10% over the term you will receive the maximum return of 41.5%.
Fair Investment view: This plan has proved popular due to the higher multiple used compared to other similar plans. The maximum return equates to just under 6% compound annual growth which is considerably higher than current market leading savings rates however the return is not guaranteed and if the FTSE only rises by a small amount or falls, you may have been better off with a fixed rate. Click here for more information about the Societe Generale UK Super Tracker Deposit Plan »
Finally, for those who do not wish to have any cap on the overall return available, Investec’s Deposit Growth Plan offers 140% times any rise in the FTSE 100 and has a five year term rather than six. If there is no rise in the Index or it falls, you only receive a return of your capital. Click here for more information on the Investec Deposit Growth Plan »
Replacing a fixed rate with the potential for a higher income
For those looking for an annual income, our selection of fixed rate bond alternatives includes Investec’s Target Income Deposit Plan which offers the potential to provide 5% income each year. The closing level of the FTSE 100 Index is taken at the start of the plan and if the value of the Index finishes higher than 90% of this level at the end of each year (subject to averaging), you receive 5%. If the Index finishes below 90%, no income will be paid but should it meet the required level on any future anniversary, any missed payments will be added back.
Fair Investment view: With inflation eating into historically low savings rates and the market for longer term fixed rates looking dire, this could be an attractive alternative for those prepared to sacrifice a guaranteed return in the hunt for higher potential returns. Click here for more information about the Investec Target Income Deposit Plan »
Higher fixed returns
The need for income is one of the most consistent demands put on our capital and for those prepared to put their capital at risk in order to provide a higher fixed income the Enhanced Income Plan from Investec offers 5.64% fixed each year, paid to you regardless of the performance of the stock market. This is paid in monthly installments of 0.47% and there are no other set-up fee or annual charges.
The trade off for a fixed income which is well over double the rate of inflation and significantly higher than any return available from fixed rate bonds is that your capital is at risk. This investment contains what is known as conditional capital protection which means that your initial investment will be returned in full unless the FTSE 100 Index falls by more than 50% during the investment term. If it does, and the Index also finishes below its starting level then your original capital will be reduced by 1% for each 1% fall. Therefore, this plan should only be considered if you are prepared to lose some or all of your capital.
Take the situation where £25,000 matures from a 3 year fixed rate bond. If this bond was paying 4% and our leading rate is only paying 2.51%, this is a reduction from £1,000 each year to £627.50, a difference of £372.50, equivalent to a reduction of over a third.
In order to match the original level of £1,000 income, £12,000 would need to be invested in the fixed income investment, with the remaining £13,000 in the three year fixed rate. The additional risk involved by taking this route is that the £12,000 allocated towards the investment is at risk. In addition, the investment has a six year term rather than three and so you are committing your capital for longer.
Fair Investment conclusion
Commenting on the investment, head of savings and investments at Fair Investment Company, Oliver Roylance-Smith, said: “The high level of fixed income and the monthly payment frequency are attractive features of the Investec Enhanced Income Plan and with savings rates continuing at historically low levels there is clearly pressure on savers to think long and hard about what to do with their money.”
He continued: “Unlike savings plans, investing puts your capital at risk and so you should only consider this investment is you are prepared to lose some or all of your initial capital. However, should you consider the need to move some of your capital into an investment or are considering additional investments or ISA transfers, this plan could be a compelling opportunity to provide a high level of fixed income while offering your initial capital some protection against a falling market”.
Cash ISA transfer option
Low interest rates have also created an increasing trend of savers transferring their Cash ISAs to Investment ISAs in an attempt to try and counter the challenges they face by giving up the security of cash for potentially better returns.
Transferring your Cash ISA can be done without the loss of your ISA wrapper and it will not affect your annual ISA allowance for the current tax year. However, if you are considering this option you should be aware that Cash ISAs and Investment ISAs are very different and that Investment ISAs such as the Investec Enhanced Income Plan do put your capital at risk. Also note that once you have transferred to an Investment ISA you cannot transfer back to a Cash ISA.
ISA season upon us
For those who are on the ball and looking to make the most of their ISA allowance, again this is an important area. For basic rate tax payers, utilising this annual allowance increases the amount of any interest paid by 25% whilst for higher rate tax payers this increases to 66% so is not to be ignored. Those looking for transfer options for their existing Cash ISAs or to make sure they use their Cash ISA allowance of £5,760 must do so by the 5th April.
Please note that the tax treatment of ISAs depends on your individual circumstances and may be subject to change in the future.
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.
Although 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. Returns are not guaranteed. The past performance of the FTSE 100 Index and any of it shares is not a guide to its future performance.
The Investec Enhanced Income Plan is a structured investment plan that is 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.