Locking into a long-term deal now could leave you on a sub-par rate for years to come, warns John Fitzsimons.
After a dreadful couple of years for savers, things may be finally starting to improve, at least in terms of the interest rates on offer.
The handful of increases to the Base Rate that we have seen in 2022 so far have succeeded in finally boosting the rates on offer to savers looking to squirrel away a bit of cash each month.
New analysis from the financial information site Moneyfacts shows that, for example, the average rate available on an easy access account today is 0.84% ‒ the highest level seen in a decade.
Similarly, the average rates on one-year fixed bonds and longer-term bonds have not been higher in a decade, while the level of choice on offer has improved for seven straight months.
Now, the obvious downside is that even the top rates still don’t come close to matching inflation, meaning that the money you save is still losing value in real terms.
Yet there’s something a bit more palatable about locking your money up for a year and getting a rate of above 3%, compared with the table-topping deals of recent years, which had even dipped below 2%.
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The best of the best
However, it’s important to bear in mind that just because a particular account is the best of its kind, or market-leading, that doesn’t mean it’s actually a good option.
The fixed-rate bond market at the moment provides us with the perfect example of this.
Right now the best rate that you can get on a one-year fixed-rate bond is 3.32% from Close Brothers ‒ lock your money up for a year and you’ll get that rate.
By comparison, the highest rate on offer from a five-year fixed-rate bond is 3.75% from the Bank of London and the Middle East (BLME).
In other words, lock your money away for an additional four years and you’ll only enjoy an extra 0.43% on your money.
The only way is up
That seems like an incredibly poor move to me. We have already seen Base Rate rise a handful of times since December, off the back of the incredible rates of inflation we are facing.
However, those increases are yet to pay off, with inflation still incredibly high. Sure, it dropped this month, but it still stands at 9.9%, meaning costs are rising at almost their fastest rate in four decades.
As a result, further increases are all but a certainty - analysts believe the Base Rate could rise from 1.75% to 2.25% this week and hit 3.75% next year.
That means it likely won’t be long until a current five-year rate is eclipsed by deals available over a shorter term, which would be a disaster for savers who have opted to fix for such a long period.
They will be stuck with their money in an uncompetitive account, watching the returns on one- and two-year fixed rates eclipse it.
And what’s even worse is that they can’t do anything about it without sacrificing the now mediocre returns they have already got from the account.
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Looking ahead
It’s an important reminder of how savers need to take a long-term view when selecting a new home of their cash.
It’s not enough to simply look at the best buy tables and go for the highest possible rate on offer.
Just because you might not need that cash for a five-year term doesn’t mean that a five-year bond is automatically the right option.
We are in a rate-rising environment, with the financial markets expecting Base Rate to be as high as 4.25% in a year’s time.
Given that context, it makes more sense to perhaps lock your money up for a year initially, and then once it appears that Base Rate is settled ‒ or potentially even set to fall ‒ then you can lock in the best rate on offer for a longer period.
It’s been a long time since we’ve seen savings providers actually deliver rates that aren’t outright derisory, so it’s understandable that some savers will be excited about snapping up the highest rates on offer.
But patience and an understanding of what likely lies ahead will mean you get a better return in the long run.
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