Even the best savings bonds are rubbish!

Find out why locking your savings away in a fixed rate bond gives you very little reward.

In the days when the best buy one-year fixed rate bonds paid a cracking 7% rate, you really couldn’t go far wrong. Given that savers didn’t have to take any risks with their cash, this was a fantastic return.

But you won’t get anywhere near rates like this today. In fact, the market-leading 12-month bonds are paying just 3% which looks paltry by comparison.

Having said that, while the rates on offer today are a far cry from where they once were, bonds still provide a guaranteed return which may be important to some savers.

Of course, you’ll always know exactly how much interest will be earned over the set term, so you won’t need to keep an eye on the rate until the bond matures - and you may be perfectly happy with that.

Do bonds offer savers a good deal?

But is it a good idea to tie your savings up in bonds with relatively low rates? Well, that all depends on the returns available on other types of savings accounts. But before we think about that, let’s take a look at the best short-term bonds on the market today.

If you’re happy to lock your savings away for a year, you can earn 3% at the Post Office with the Growth Bond. You’ll need a minimum deposit of £500 but you won’t be able to make any withdrawals during the term.

You can close the bond early if you need to get at your savings out but this will trigger a ‘bond breakage charge’. This charge will be calculated at the time you ask to close the bond, and could mean you actually end up getting back less than you invested. For this reason, you should only choose the Post Office if you’re absolutely sure you won’t need to touch your savings before the bond matures.

Alternatively, Barnsley Building Society is also offering 3% on the new 1 Year Fixed Rate Bond. This time you’ll need a minimum of £100 to get started, and there are no partials withdrawals or early closure permitted during the 12-month term. Interestingly, additional deposits of £1 plus can be made into the bond at any time.

ICICI has also just increased the rate on its one year HiSave Fixed Rate Account to 3% equalling the existing market-leaders. For this partcular bond you must be able to save at least £1,000. No additional deposits, withdrawals or early closures can be made during the fixed term.

How do they compare with ordinary savings accounts?

On the upside, while 3% isn’t exactly a spectacular return, these bonds do offer a guaranteed rate which you might consider to be pretty valuable in a long-standing low interest environment.

But I’m not convinced. By sacrificing access to your savings, I think you deserve to earn a significant premium over ordinary savings accounts. Sadly, this just isn’t the case.

Check out the table below which shows the top rates you can earn today without having to lock your money away at all. Any account which operates withdrawal restrictions has been excluded:

Top easy access savings accounts

As you can see, if you chose Alliance & Leicester Online Saver Issue 7, instead of a top one-year bond, you would sacrifice just 0.19% in return for full access to your savings. And, while it’s true this rate isn’t fixed, unlike the bonds above, you'll always have the option to switch if you feel your return is becoming uncompetitive.

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On top of that, you’ll have far more flexibility. You can draw on your savings whenever you like without penalty.

What’s more, if the rates on other easy access accounts start to improve, you can capitalise on the higher returns by switching your A&L or ING account to the latest market-leader. But you won’t have that opportunity when you’re tied into a 3% bond.

Personally, I think the margin between the rates paid one-year bonds and ordinary savings accounts just isn’t wide enough to consider locking your money away right now.

What about longer term bonds?

Of course, you could earn much more generous rates with a long-term bond. If you lock your money away for five years, a fixed rate of 5% is on offer from the ICICI HiSave Fixed Rate Account. But there’s a big risk variable rates could improve significantly over this period, leaving the bond lagging behind.

At lovemoney.com we generally recommend you lock your money away for no more than two years to limit the chance of your return being overtaken by new easy access accounts. But are the rates high enough over this term to justify choosing a bond? 

The good news is you can earn noticeably better fixed rates over two years compared with easy access savings. The best two-year bond from Kent Reliance Building Society pays 3.75% - this is 0.94% higher than the top account from A&L.

If you think variable returns won’t improve beyond this rate over the next couple of years, go for it. That said, while your decision may be a closer call in this case, I’m still sceptical!

How about a high interest current account instead?

Finally, I think a better option could be to stash part of your savings in a high interest current account instead. The best buys pay a fabulous rate of 5% and give you instant access as often as you need it. Take a look at the table below to find out more.

You should bear in mind that the Premier Direct Current Account requires a minimum monthly deposit of at least £500, while you must pay at least £1,000 a month into the Preferred In-credit Bank Account or the Classic with Vantage account.

With both the Alliance & Leicester and Santander accounts balances over £2,500 earn just 0.1% and the 5% rate will drop to just 1% in 12 months' time so be prepared to switch your savings.

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