It pays to fix your savings
Guest blogger Richard Brown of first direct looks at how to get the best return from your savings.
With the Bank of England holding interest rates at an historic low of 0.5% for almost two years, many people are concerned at the lack of encouragement for savers. Coupled with a high inflation rate of 4%, many savings accounts are struggling to offer any real returns.
One solution for savers hoping to get the best rates is to take out a fixed rate savings account or bond. However, savers must first weigh up their needs with the high returns of longer term products.
A better return
Analysis of average savings rates over the past five years has shown that fixed rate deals have offered better returns than variable rate products during the period. Since the base rate first plummeted in 2008, the difference between the average interest on fixed rate savings and that on variable rate savings has been particularly marked. The average variable rate return has not been above 0.25% in the last two years according to the Bank of England, whereas the average return on fixed rate savings was 3.3% in 2009 and 2.75% in 2010.
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For a saver who had put away the average savings balance, an instant access account would have returned just over £9 in two years, whereas savers putting the average savings total away into fixed rate savings would have gained just under £150 from the same amount. Even before the credit crunch, average interest rates on instant access accounts were never above 3% while the average fixed rate return reached 5.36% for savers putting their money away in fixed rate accounts in January 2008.
Our analysis shows that over the past 5 years savers who put their money away for the longer term earned on average £78.50 per year more than those who choose the lower return on instant access accounts.
Access to your cash
Before you choose to tie up your savings in potentially higher return fixed rate accounts, you must carefully assess what you need your savings for and make sure that you do not need instant access to your money. For example, if your savings are there to act as a salary cushion in case you are made redundant, it is no use if they are locked in a fixed rate savings account that you can’t access without penalty when you really need it. Most accounts charge a fee for accessing your money before maturity which is typically 90 days' interest.
Base rate rises
Additionally, while the base rate is currently at historically low levels, it is not easy to predict which way rates will go. Last month, three out nine members of the Bank of England’s Monetary Policy Committee voted for a rise in interest rates to combat rising inflation.
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It is possible that other members could follow suit and abandon the ‘dove’ stance in favour of a more hawkish policy in the coming months, as inflation is predicted to rise over 5% by the end of the year. Should interest rates rise to pre-credit crunch levels as some are advocating, variable rate instant access savings could offer better returns as well as flexibility for savers.
Banks and building societies price their fixed rate bonds from ‘wholesale’ or ‘swap' rates, which are based on market expectations of future base rate rises, so any expected rise would usually be factored in, however nothing is set in stone and there is an element of crystal ball gazing.
Best of both worlds
A solution for savers to get the best of both worlds is to split their money. It is advisable for people to establish a rainy day fund to be used in the event of unexpected events such as redundancy or illness. The minimum advisable precaution is to put aside enough money to support yourself for three months, which should be easily accessible.
It is also worth savers assessing how likely it is that they will face additional unexpected expenditure, such as their car breaking down or emergency home repairs, and to save enough in an easy access account to be able to cope with any nasty surprises. Read The top 15 easy access savings accounts
If savers are savvy, they can make the most of the best buy rates for instant access Isas, meaning that their money is still earning tax free interest, even if it is not as high as that of a fixed term account. Read Top new ISAs for savvy savers
Any further savings could then be deposited in longer term fixed rate accounts which would earn more interest in the long run. Another useful tip is to save in multiple fixed rate accounts which mature at different points in the year, meaning that you are never more than six months away from one of your policies maturing.
In summary, when deciding what to do with your savings, the old adage of not putting all your eggs in the same basket applies and it is advisable to have a mixture of savings in accounts that can be easily accessed in addition to having some that you are able to tie up for longer periods.