How to get a better return on your savings
With saving rates still at a low level, how can you ensure your cash gets a real income boost?
Saturday 24 October 2009
Anyone relying on their savings and investments to boost their income has had a hard 2009 with savings rates, in particularly, at record lows. The prospects are not looking good either with the retail price index, which measures the rate of inflation, actually negative, and the Bank of England base rate being held for months at a historically low 0.5 per cent. So what can you do to boost your income? We survey the options.
Pay down debt
The interest you are paying on loans or credit cards is likely to be several times higher than you are receiving on any savings or investments. So if you have spare cash it always makes sense to reduce unsecured borrowings on credit cards, personal loans and overdrafts, starting with the most expensive.
Rates charged on a £5,000 overdraft average nearly 19 per cent, while rates on unsecured personal loans average around 13 per cent. When you're getting paltry sums on your savings, it makes clear sense to use the cash to cut your debt charges. However, you need to ensure there aren't early repayment penalties on your loan first before paying it off. Even if there are, you still might be better off repaying it early.
Find out the total cost of borrowing figure for your loan (your lender will provide this), then deduct the amount of interest you have already paid and the amount of any early repayment penalty. The amount left is the figure you could still save by clearing the debt in one go.
Similarly, if you have an offset mortgage, which allows your savings and current account credit balances to go towards reducing to the amount you owe, it makes sense to use spare cash to reduce your loan size. It's the equivalent of earning interest on savings at your prevailing mortgage rate.
And with the average cost of a tracker mortgage sticking around the 3.85 per cent mark, slightly lower than average standard variable rates, you're saving more than you would earn on most taxable high-interest savings accounts. The savings are even higher if you are locked into a fixed-rate mortgage deal – average five-year fixed-rate loans are currently 5.68 per cent.
Cash savings accounts
Martin Bamford of the independent financial adviser Informed Choice says: "You have to ask yourself how much risk you are willing to take with your money. If the answer is none, you have to stay in cash. But there are still huge variances in the rates you can get, so check the market at least once a year and be prepared to switch accounts."
Mr Bamford points out that although savings rates look low, the gap between the inflation rate and the best savings rates is actually quite high. "Things aren't as bad as they seem in real terms," he says.
The ISA rules have changed from October to allow those 50 and over to put up to £5,100 into a cash ISA each year rather than £3,600. The stocks and shares ISA limit has also risen to £10,200 from £7,200. If you're below 50 you'll have to wait until April 2010 for the new thresholds to kick in.
Brian Dennehy of the independent financial adviser Dennehy Weller & Co says: "The increase in the cash ISA limit isn't making any difference at all. People are regretting going into cash ISAs in the first place. There are good income options around in riskier investments."
The bad news is that many cash ISA providers have been reducing their rates in recent months. The average rate of the top five cash ISAs is now around 3 per cent for those depositing at least £3,000, but at least your interest is tax-free. Rates are changing fast, so check on price comparison websites such as Moneyfacts.co.uk and Moneysupermarket.com, and make sure you know whether the interest is paid monthly or annually and whether there are any withdrawal penalties.
Rates on the highest-paying easy access savings accounts are also currently around 3 per cent, while some regular saver accounts, such as Halifax's, will pay a fixed rate of 5 per cent providing you save between £25 and £500 a month.
Traditionally, agreeing to tie your money up for a few years in a fixed-rate bond has earned you a higher rate of interest. And five-year fixed-rate cash ISAs are offering up to 4.5 per cent at the moment. But Bamford warns: "Don't fix your savings for too long – a year or two at the most – because interest rates are likely to rise and you could lose out if you're tied up for too long."
Gilts, or government debt, used to be seen as the safest form of investment. The Government couldn't go bust, could it? But after the financial crisis and UK government debt spiralling to £800bn, some commentators are beginning to worry.
John Kelly of Chelsea Financial Services says: "The gilts market is a car crash waiting to happen. There are growing worries about the Government's ability to repay its debt."
The Bank of England has been committed to buying up to £175bn-worth of gilts as part of its quantitative easing policy to kick-start bank lending and stabilise the financial markets. This has repressed gilt yields.
And under new liquidity rules imposed by the Financial Services Authority, banks are being forced to buy gilts over the next few years to protect themselves against future shocks. This could have pushed gilt yields up again, but analysts think the effect of the bank purchases has already been priced in. At the moment yields on two-year gilts remain below 1 per cent, while yields on 10-year gilts are trading at around 3.4 per cent per cent.
Brian Dennehy says: "Gilt yields are so low you'd almost be better leaving your money on deposit." In short, investors looking to boost their income will be better off looking elsewhere.
Corporate bonds and equity income funds
There is no getting away from the fact that if you want your cash to produce more income in the current climate you have to take more risk. This means accepting the possibility of your capital reducing in value.
Although corporate bond and fixed interest funds are considered less risky than equities, they are certainly not risk-free, and some higher-yield bond funds can be riskier than some equity income funds. But if you can take a medium-to-long term view (5-10 years) you may feel a degree of risk is worth taking for the higher yields they can provide.
Many investors certainly seem to think so. According to Trustnet, the fund information website, four out of five of the funds attracting the most money over the last month were corporate bond or income funds, investing in corporate and government debt.
Brian Dennehy says: "We've noticed a huge volume of our clients switching out of cash ISAs and into corporate bond ISAs."
Mark Dampier, head of research for Hargreaves Lansdown, says: "We believe the wider economic backdrop is also positive for corporate bonds. With an economy burdened by rising unemployment and huge debts, inflation is unlikely to materialise in the short term. Interest rates are also likely to remain low because I think the Bank of England will not raise rates too quickly and risk stalling the recovery when it comes.
"So with bonds still paying around 5 per cent, the yields continue to look compelling – especially when you receive the income completely tax-free in an ISA."
Hargreaves recommends M&G Optimal Income, currently yielding 4.89 per cent. This is variable, and unless you shelter it within an ISA will have tax deducted from the income.
John Kelly, of Chelsea Financial Services, says: "When you factor in inflation and tax, you will probably be getting a negative real return on high-interest accounts, so we've been recommending corporate bond and equity income funds to our clients."
In particular he recommends the Invesco High Income and Schroder Income Maximiser funds.
But all corporate bond funds are not the same, Mr Dennehy warns. "People need to keep an eye on whether a fund's priority is total return [income and capital growth] or income only. If a regular income is most important to you there are actually only a handful of funds that focus on this."
He recommends Investec Monthly High Income for this category of investor, which is currently producing a yield of over 8 per cent.
Now you might think that this type of high-yielding fund, which invests in fixed-interest corporate and government securities, would inevitably mean an erosion in your underlying capital. Not so. Investec's fund has actually grown 30 per cent over the last five years. So it is possible to achieve capital growth and much higher level of income than you would ever receive from cash accounts.
But Martin Bamford warns investors not to get too carried away. "Although we've seen a huge move towards corporate bond funds because of their attractively high yields, the risk to capital is extraordinary if you put all your eggs in one basket – you could lose 20 to 30 per cent. We wouldn't advise more than 30 per cent of your portfolio to be in corporate bonds."
Independent Partners; request a free guide on NISAs from Hargreaves Lansdown
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