Fixed rate savings bonds offer fantastic rates, but with banks in chaos, is it sensible to lock your money away now?
It's always been Foolish to find the best possible return on your savings. Indeed fixed rate bonds have been popular with savers for that very reason with fantastic rates regularly on offer. These days, it's easy to get hold of a bond which pays a stunning return of 7% or more.
Of course, with rates this good there's bound to be a couple of hitches. Here's a rundown of the pros and cons of fixed rate bonds:
The pros
Bonds usually offer a generous rate of return on your savings.
The rate is fixed for the term of the bond which means you'll know exactly how much interest you'll earn upfront. What's more, you don't need to worry your rate will be slashed shortly after opening the account.
There's no need to shop around for a new account until the term has come to an end.
Your savings will be locked away, so there's no opportunity to fritter your cash!
The cons
But on the flipside, locking your money away means there's usually no access to your cash -- even in an emergency. With some bonds you may be able to make a withdrawal, but there will probably be a heavy penalty.
Interest rates on bonds are very attractive at the moment, but there's no way of telling whether the rate you're fixed into will stay ahead of the competition for the duration of the bond.
The full amount you want to save must be available from day one. There's no opportunity to top-up the bond further down the line.
If the downside doesn't worry you too much and you can afford to lock your money away for a while, then fixed rate bonds may be tempting. And I'm sure you won't be disappointed by the rates.
Take the new One Year Internet Fixed Rate Bond from the AA. If you have £500 or more to invest, you could earn a great rate of 7.21% AER. This is one of the best products on the market and certainly the most competitive for smaller deposits.
But beware no access is permitted at any time, so you must be sure you won't need your money back early before you commit. That said there is an option to take the interest earned as a monthly income from the bond, rather than waiting until maturity.
The ICICI Bank UK HiSave Fixed Rate Bond is just behind the AA with a rate of 7.20% AER on deposits of £1,000 or more. Again there's no access to your money with this particular bond which matures after one year.
But are bonds a good idea?
It's certainly difficult to find a savings account good enough to beat the best-buy fixed rate bonds. But does it make sense to lock your money away now?
Some Fools have asked how safe are savings held in fixed rate bonds if the bank goes bust? And do they have the same compensation rights under the Financial Services Compensation Scheme (FSCS) as easy access savings accounts?
As a quick reminder, the FSCS guarantees that up to £35,000 of your savings is protected in the event of the bank/building society you save with collapsing. However, the compensation limit is being raised to £50,000 on 7 October. Read more about compensation here.
In relation to fixed rate bonds, if the bank in question goes bust, the FSCS will effectively take over your bond for the remaining term. If no access to your money is permitted at any time before maturity, you will need to wait to the end of the term before you can make a claim under the FSCS for compensation. You will then be entitled to claim for the capital deposited in your bond plus the interest you would have earned over the term up to the new maximum of £50,000.
What about bonds with access?
The situation is slightly different if your bond allows some access. For example, if you're able to make a withdrawal from the bond with 30 days' notice, then you can make a claim for compensation under the FSCS once that time has elapsed. You won't need to wait until the bond's original maturity date. Some bonds offer the option to close early. In this case, you would be able to make a claim under the FSCS straightaway.
In a nutshell, the access permitted under the terms and conditions of your bond will determine when you can make a claim for compensation.
Crucially, the maximum amount of compensation available for fixed rate bond savings is exactly the same as easy access accounts. Although -- as I have already mentioned -- you may have to wait some time before you can make a claim under the FSCS.
This may be enough to make you feel uncomfortable with the idea of locking your money away despite the impressive returns. I can certainly understand that in light of the current banking crisis.
But, to put things in perspective, remember savers in the UK have not yet had to turn to the FSCS for compensation during the current crisis.
The beleaguered banks -- Northern Rock, Bradford & Bingley and HBOS -- have either been nationalised or rescued by other banks. And no savers have lost any money as a result of a bank running into trouble so far.
More: The Safest Way To Save (And Beat Tax & Inflation) | Compare savings account at The Fool