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Spend & Save

Everyone is jumping on the bond wagon

Fixed-rate investments carry a risk but they could provide a good return in these days of low interest rates, says Alessia Horwich

There may be light at the end of the savings tunnel. Over the past few weeks, a number of new fixed-rate accounts have appeared paying in excess of 4 per cent for terms between one and five years. However, although many will be tempted to jump at the chance to make a decent return on their cash, tying up your money now when no one can predict economic movements could be risky.

The base rate has stuck at 0.5 per cent for the past two months, but in the same space of time the number of fixed rate deals has risen sharply. At the beginning of March, as few as five fixed-rate accounts could be found around the 4 per cent mark; today there are 75. "Banks are looking at their savings books and trying to lock money away to use as their lending capital," says Michelle Slade, spokeswoman for online information service Moneyfacts.co.uk. As a result, competition between banks to get their hands on your cash is fierce.

Even the Government has cottoned on, raising the rates on NS&I income bonds by 1 per cent to 1.71 per cent for deposits below £50,000 and 2.02 per cent above. These investments are not technically bank accounts, but mini-loans to the Government on which they will pay a monthly dividend. That said, the rate change is indicative of what other banks in the market are thinking about their savings rates. "In this volatile period, everyone is trying to find the right level for the right product," says John Prout, NS&I customer sales and retention director. "We are looking at the marketplace and trying to bridge the gap between our bonds and other similar products."

The latest bank to up its fixed-rate account returns is Indian outfit ICICI, which now offers 4 per cent (up from 3.45 per cent) on a one-year bond, 4.35 per cent for two years and 4.40 per cent on a five-year bond, all with a minimum deposit of £1,000. For those with less to put away, the Bank of Cyprus UK pays 3.70 per cent on a one-year bond with a minimum deposit of £1. As always, the longer you are willing to part with your money for, the better the return you will get, but putting such restrictions on your money for a considerable length of time comes with downsides. And despite the Icelandic banks fiasco, don't necessarily be put off by a non-native bank. To trade in the UK, financial institutions need a banking licence, and that means the same protection under the Financial Services Compensation scheme.

But you might not want to jump in to a long-term deal just yet. Interest rates are pitifully low and so a return of 4 per cent is substantial in comparison. But interest rates should rise. This could mean that you are tied into a deal paying 4 per cent, when other accounts are paying more. For shorter-term bonds, this isn't such a worry. "The short-term outlook says interest rates aren't going anywhere soon, so locking in for now seems a good deal," says Darius McDermott of independent financial adviser Chelsea Financial Services. "But it depends of the length of the bond. A 4 per cent bond over three years looks extremely attractive, but for four or five years you just don't know."

Tying up your money can be a gamble. "I am uncomfortable about people buying into tied products for long periods," says Jason Butler, a partner at Bloomsbury Financial Planning. "When rates drop abnormally it's a short-term aberration, and you shouldn't make long-term decisions on a short-term scenario. When you tie your money up, you should do it only if the return is more important than everything else." If drawing an income is the only requirement, a savings bond will provide this security. However, if you do have some flexibility, variable savings that rise in the future may offer similar average returns over time as a fixed-rate bond.

If you are willing to take the risk of tying up your money but want much more in return, it could be worth considering corporate bonds or equity income funds. These are not cash investments, but will pay a monthly return or dividend and you also have the potential for capital gains on your original investment. Mr McDermott says, "Corporate bonds are looking extremely attractive. With interest rates at 0.5 per cent and dividends around 5 per cent, equity income could also be a good strategy for medium- to long-term holders."