Don't lock away your savings for five years

Rates are so poor on savings accounts these days, there's little point locking away your money for long periods, certainly not for five years.

When I write an article about savings accounts, my normal line is that instant access accounts are all very well, but you’ll get a much better return if you’re prepared to lock away your money for several years. Usually in a fixed rate bond.

But interest rates on savings accounts are so low these days, I’m not sure that’s true anymore.

Look at the following tables which show the top-paying easy access accounts right now and top-paying five year bonds:

Easy access accounts 

Five-year bonds

So the best five-year account pays 3.05% while the best easy access account pays 2.3% - a tiny difference of just 0.75%. To put it another way, if you had a spare £1,000 to put in a savings account, you’d only earn an extra £7.50 a year if you locked away your money in the FirstSave five-year bond rather than the easy access West Brom WebSave Plus 3.

Now you could argue that £7.50 is still worth going for if you’re sure that you won’t need the money at any point in the next five years. But my concern is that interest rates might rise during that time and you’d feel rather fed up as rates on many accounts rose while you remained stuck on 3.05% until 2018.

Higher rates on savings accounts could be triggered by three possible factors:

- Increases in the Bank of England’s base rate

- Rising yields on gilts (government bonds) which would particularly affect fixed rate bonds

- The winding up of the Government’s Funding for Lending scheme next year

In fairness, I suspect that only one of those factors will kick in within the next two years – the wind-up of Funding for Lending. So interest rates probably won’t rise that much before 2015 and you could just about make a case for going for a two- or three-year bond.

Three-year bonds or less

But even then, if you went for the Vanquis Bank High Yield three-year account, you’d only get an extra 0.66% a year compared to the top easy access account. That’s not much of a return for losing control of your money for three years as well as the risk that interest rates rise more quickly than I expect.

Alternatives

So are there any alternatives out there?

Well one option is to lend to your money to other people via the peer-to-peer lending sites such as Zopa and Ratesetter.

You could earn as much as 6% on your money if you’re prepared to lock away your money for five years. (6% is the kind of return that makes locking away your money a much more attractive proposition.) Read more in What is peer-to-peer (P2P) lending?

Or you could switch your current account to the Santander 123 current account where you could earn 3% on any balances between £3,000 and £20,000. You will, however, have to pay in at least £500 a month and you’ll also have to pay a £2 monthly fee for the account.

For many people, I think the best option will be to go down the peer-to-peer route. But whatever you do, don’t go for a five-year bond. There’s just no point!

More on savings accounts:

Building societies restrict savings accounts to local residents only

Bank of England admits Funding for Lending to blame for dismal savings rates

The top fixed-rate savings bonds

The best instant access savings accounts