How can you safeguard the return on your cash?
This article was first sent to Fools as part of our 'Afternoon' email campaign.
I don't think anyone expected the extraordinary 1.5% cut to the base rate last week. And it looks like more reductions could be on the way. This is pretty bad news for savers.
When the base rate falls you can be sure savings rates will soon follow. So how can you safeguard the return on your cash?
The obvious answer is to go for an account which offers a fixed rate. That way, it doesn't matter what happens to the base rate, because you'll be enjoying a guaranteed return.
But to earn a fixed rate you'll almost certainly have to lock your money away for a while. I'm a little nervous about tying cash up in the current climate, as I explained in this article. But I understand that many of you don't want the rate on your savings to dwindle away if the base rate drops again.
So, here are five ways of protecting your savings from further rate cuts:
1. Fixed rate bonds
It's still possible to earn a return way above the base rate with a fixed rate bond. But don't forget, if you need access to your cash, bonds aren't the way to go. My Foolish friend, Rachel Robson, covered the best rates in her recent article, with the market leader still offering 7% (at the time of writing.) But don't be surprised if that rate doesn't last. Bond providers are trimming rates back all the time, so you'll need to be quick.
Just a quick word on safety: Many of the bonds which pay the best returns right now are provided by foreign banks operating in the UK and are protected by dual or foreign compensation schemes. This may not worry you, but I would prefer a bond which is covered entirely by the UK Financial Services Compensation Scheme (FSCS). If it's a concern for you too, check out how your bond savings would be protected first.
2. Guaranteed income bonds
As the name suggests, guaranteed income bonds -- or GIBs -- provide a fixed income for the term of the bond.
GIBs are provided by insurers and are normally set up as long-term life insurance contracts rather than as a savings account. This means they qualify for a different level of compensation under the FSCS. In the event of the insurer who provides your bond going bust, you'll be covered for 100% of the first £2,000 and 90% of the rest of the claim. So unlike a conventional savings account, there is no maximum limit on how much compensation you may receive.
Usually, you can take a bond out over one to five years, and you may be able to choose how regularly you take the income. You won't normally be able to make withdrawals before the bond matures. But your capital is guaranteed to be returned to you at the end of the term - unless the insurer goes bust.
You could earn a preferential return by taking your bond out through an independent financial adviser. Baronworth Investment Services, for example, specialise in this area and may be able to offer clients significantly higher rates for larger investments. (Visit www.baronworth.co.uk for more details.)
3. Guaranteed growth bonds
Guaranteed growth bonds work in the same way as GIBs, but are better suited to those who don't want to take an income. Your return will roll up throughout the term and be paid at maturity. You should find that returns are slightly higher for growth bonds when compared with the same insurer's GIB rates.
You should also be aware that neither GIBs nor guaranteed growth bonds are suitable for non-taxpayers. Interest is always paid net and the tax that has been deducted at source can't be reclaimed.
Just make sure you don't confuse these bonds with guaranteed equity bonds which are a different kettle of fish and should be avoided.
4. Fixed rate cash ISAs
Again, fixed rate ISAs provide a guaranteed rate in return for locking your money away. At the moment, the market leader is the Bradford & Bingley One Year Fixed Rate ISA which pays 6.25% tax-free. That's going to be pretty hard to beat! But don't forget you can't save any more than £3,600 into cash ISAs this tax year.
5. NS&I Index-linked savings certificates
National Savings & Investments (NS&I) Index-Linked savings certificates are a bit different from the previous four options because the rate isn't fixed in the same way. But your return is guaranteed to beat inflation plus a fixed percentage on top, so I think they deserve a mention.
You can save between £100 and £15,000 in each issue over three or five years. You'll earn a tax-free return which is linked to the retail prices index (RPI) plus 1%. Today the RPI stands at 5%, so with the 1% bonus, that's equivalent to an attractive tax-free return of 6%.
Even better, NS&I is backed by the Treasury, so it's one of the safest places to keep your cash, alongside Northern Rock. But -- on the downside -- if the RPI falls so does your return. And there's no access if you want to earn the maximum rate.
Widespread rates cuts are definitely on the cards. In fact, it's already happening, so you may want the certainty of a guaranteed return. Of course, you might prefer to take your chances with a variable rate savings account. But whatever you choose to do with your savings, best of luck!
More: Find Out How Safe Your Bank Is | The Smartest Savings Account In Britain! | Is The Party Over For Savers?