Thrifty Living: Don't settle for a second-rate savings return

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The Independent Online

The Bank of England cut interest rates another 0.5 percentage points this week, taking them to all-time lows of just 1 per cent. While this may be good news for those who have tracker mortgages, it's bad news for the millions of savers who are now earning next to nothing on their deposits in the bank.

As a result, it's now more important than ever to take a review of your savings arrangements – to ensure you're squeezing as much interest out of them as possible. While the average savings account is paying less than 1 per cent, there are still a number of providers who are offering over 4 per cent. And if you're willing to take on a small amount of risk with your capital, there are even better returns available.

Savings accounts

The best savings rates can be found in the accounts where you tie your money up for a year or more. ICICI, for example, is still offering 4.3 per cent on its one-year fixed-rate bonds, while First Save – which is owned by First Bank of Nigeria – is paying 3.6 per cent. Both of these banks have the full protection of the UK Financial Services Compensation Scheme – meaning 100 per cent of your money is protected up to a limit of £50,000.

If you've got more than £25,000 to put away, the Investec High 5 account is a good option – it promises to pay the average rate offered by the top five instant access savings accounts, which at the moment is 4.07 per cent. However, you need to give three months' notice to withdraw your money.

If you put something aside every month, there are even better rates to be found. For example, Barclays is paying 6 per cent for people who save between £20 and £250 a month.

With all these accounts, remember that tax is deducted from the interest you receive. Make sure you use your full £3,600 cash ISA allowance each year, as there's no interest to pay on money in these accounts. Abbey currently offers one of the best ISA rates, at 4.25 per cent. However, you need to agree to invest at least the same amount of cash in one of Abbey's investment products to qualify. Halifax is offering a four-year ISA at 4 per cent.

To search for the best savings rates, visit www.moneyfacts.co.uk.

Corporate bonds

If you're willing to take some risk with your capital, you can potentially earn a much better rate of return. One of the best lower-risk options at the moment are corporate bond funds, which invest in the debt of companies. Professional fund managers believe that these represent particularly good value today, as the lack of confidence in the credit markets means that prices are still not accurately reflecting the level of risk that you're taking on as an investor.

Richard Woolnough, a fund manager at M&G, explains that the debt of GlaxosmithKline, for example – one of the world's largest pharmaceutical businesses – is currently yielding more than 5.2 per cent, which is around 1.4 percentage points more than the yield you'd get on a similarly dated government bond. However, two years ago, this gap between the yield on Glaxo debt and a government bond would have typically been around 0.5 percentage points. The increase in yield reflects the market's increased fear that the company might go bust. However, Woolnough believes that the premium being paid for this additional risk – not just for Glaxo, but for many good quality companies – is too great.

By buying a good quality bond fund – such as M&G Corporate Bond, Jupiter Corporate Bond or Invesco Perpetual Corporate Bond – which hold positions in many different companies' debt, you can reduce your exposure to this risk even further. Even in the unlikely event that one or two top-rated companies do default on their debt, investors in the fund should still make a profit.

Beware, however, that not all corporate bond funds are the same. Some invest only in companies with the best credit ratings, while others take on more risk. If you're unsure which one to go for, you should seek professional advice from an independent financial adviser. To find one in your area, visit www.unbiased.co.uk.

Equities

Equities are another notch up the risk scale. However, there are some good quality companies paying very attractive dividend yields – which are worth looking at if you want to get a better return on your savings than the banks or building societies are offering. Companies such as AstraZeneca and BP, for example, are paying prospective dividend yields of as much as 8 per cent – and if you believe, as some managers do, that we're close to the bottom of the current bear market, there could be some strong capital upside to be had by investing in these stocks.

Investing directly in individual stocks is risky. So if you're an amateur investor, it's better to let a fund manager do the hard work for you – by investing in an equity income fund – such as Invesco Perpetual UK Income or Liontrust First Income. Again, if you're unsure which equity income fund to go for, seek professional financial advice.

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