How to save your savings

Returns on fixed-rate savings bonds are plunging fast with the average rate on a one-year bond sinking to an all-time low. So what next for hard-pressed savers?

Millions of prudent savers who have locked their money into fixed-rate bonds are suffering as rates tumble across the board. Traditionally fixed-rate deals have paid significantly higher returns than regular savings accounts - but the difference in rates is shrinking fast.

The average rate on a one-year bond has sunk to an all-time low of just 2.62%, according to new figures from financial analysts Moneyfacts. Rates have sunk so low that you can currently find several easy access accounts paying a better rate of return.

Among the best buy easy access deals are the 2.8% AA Savings Internet Extra 3 account, the 2.75% rate on offer from ING Direct and the Tesco Bank Internet Saver deal also paying 2.75%. What’s more, unlike fixed-rate bonds, you can access your money at any time and there’s no minimum investment threshold.

Rates on longer-term bonds are also falling fast. Nine months ago the average rate on a two-year fixed-rate bond stood at 3.75%. Today you’ll typically earn just 3.16% - which equates to a whopping 18.5% drop in interest.

Yet investors looking to the long-term - such as those preparing for retirement - have been hardest hit of all. For the first time in over a year it’s impossible to achieve a 5% return on a five-year bond. The average rate, according to Moneyfacts, now stands at just 4.12%. The best return over five years is currently the 4.75% on offer from ICICI Bank UK.

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As recently as last October rates on five-year bonds climbed to a high of 5.65% - and while a rate of 0.90% doesn’t sound like much, figures from Moneynet show that for someone with a £50,000 deposit, it means a £1,800 drop in interest over the five-year term.

The great dilemma

The savage cuts in interest over the past nine months have come even though the Bank of England base rate has held steady at 0.5% for sixteen months - yet savers have more to worry about than the raw deal they’re getting at the hands of the big banks.

With CPI inflation currently standing at 3.4%, basic rate taxpayers need to secure a return of at least 4.25% to ensure their nest-egg continues to grow in real terms. A higher rate tax payer needs to earn the impossible sum of 5.67% in the current climate. What’s more, with VAT set to hit 20% in January, inflationary pressures aren’t set to disappear any time soon.

All this presents savers with a major dilemma - not least those holding the 5.5 million fixed-rate bonds set to mature this year. Figures from HSBC show that some 600,000 investors will see their bonds mature this month alone - with most investments taken out before the Bank of England slashed interest rates to 0.5%.

Those savers - who as recently as three years ago secured returns as high as 7% - are now set to suffer losses. The biggest drop in rates is on 18-month bonds, with the best buy rate of return now 3% lower than January 2009.

All of this leaves savers with two choices - either adopt a “wait and see” approach and keep their money in an easy access account until bond rates rise again, or bag one of the few inflation-beating deals on the market. It’s worth noting that opinion on future interest rate movements is currently divided. But many analysts believe it could be a full year before the base rate starts to rise again.

Where to find a better deal

Amidst all this misery, it’s vital to seek out a best buy deal - whichever type of savings vehicle you opt for. When it comes to easy access savings, in addition to the best buy ING Direct and Tesco Bank deals, savers aged 50 or above can also find a 2.75% rate of return from the Saga Internet Saver account.  

For those who want to opt for a fixed-rate bond, in addition to the five year ICICI deal, this month has seen Nationwide launch a four-year savings bond paying a not-so-bad 4.15%.

If you don’t want to tie your money up over the long-term but still want to secure a return in excess of 3%, you’ll need to lock your money away for one or two years. This week sees the Yorkshire Building Society launch a two-year fixed-rate bond paying 3.56%, while you can also secure a 3% return with the Santander 2 Year Fixed Rate Bond with no minimum investment required.

If you have a minimum of £100 to invest, you can get a 3% return over just one year with the Barnsley Building Society Online Bond. If you’ve £1,000 to stow away, look to the 3.1% one-year bond from ICICI Bank.

Compare easy access savings accounts and fixed rate bonds at lovemoney.com

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