Are your savings working for you?

September 11, 2014

Over £180 billion is languishing in easy-access accounts opened over two years ago, earning an average interest rate of less than 0.4 per cent, according to a recent study by the financial services regulator.

It is far from uncommon for savers to switch accounts in search of higher interest, but once the introductory rate expires the rates fall dramatically. Currently, if you are willing to lock your money away for three years, the best interest rate you can hope for from a high street bank is 2.3 per cent a year, or for five years the rate rises to 3 per cent.

However, setting aside the risk that rates will probably rise over the next three to five years, once you have deducted basic-rate tax at 20 per cent and taken into account inflation, which in July was 1.6 per cent as measured by the Consumer Prices Index and 2.5 per cent for the Retail Prices Index, the real return on such fixed-term deposits is likely to be significantly less than 1 per cent per annum. For most, inflation is eroding the value of their savings in real terms on a daily basis.

structured deposits

An alternative to putting your money in a fixed-term savings account is to invest instead in structured deposits. Rather than paying a fixed rate of interest each year, the returns on a structured deposit are dependent on the performance of an external reference such as the FTSE 100 Index.

With a structured deposit, compared to a fixed-rate bond, you sacrifice the fixed interest in return for the potential of achieving a better return if the FTSE 100 Index, or whatever the external reference is, performs within certain pre-defined criteria - e.g. the index is higher at the end of five years.

One example of a recently launched structured deposit is the Investec FTSE 100 Kick-Out Deposit Plan 47, which closes for investment on 26 September. The plan can run for a maximum of six years; however, it will mature early from the third annual anniversary onwards if the FTSE 100 Index, subject to five-day averaging, is above its initial index level recorded on 14 October 2014. If the plan does mature early, it will return a potential interest payment of 5.5 per cent for each year it has been in force.

Therefore if on the third anniversary, 16 October 2017, the five-day average of the FTSE 100 Index is above the initial index level, the plan will mature returning your invested capital, plus an interest payment of 16.5 per cent. If not, the plan will continue for another year until the sixth year, adding 5.5 per cent to the potential interest payment for each year.

Structured deposits have the benefit of capital protection, so even if the plan does not produce an interest payment because the stock market never rises, your invested capital will be returned in full, regardless of the movement of the FTSE 100 Index over the term.

Structured deposits are also covered by the Financial Services Compensation Scheme (FSCS). This means that if Investec Bank plc defaults during the term, you should benefit from cover of £85,000.

The risk with this plan is very similar to a deposit, other than there is a possibility that it produces no interest at all, but if the FTSE 100 is up on the fourth, fifth or sixth anniversary compared to its position at commencement of the plan the Investec deposit will outperform the equivalent fixed-rate bond.

fixed-term deposits

Investors who prefer a fixed-term deposit, rather than a deposit that has the potential to mature early, could consider Investec's Target Income Deposit Plan 14, which also closes for investment on 26 September.

This six-year plan offers an income of 4.65 per cent a year provided the FTSE 100 Index does not close 10 per cent or more below its starting level on any annual anniversary. If the index does close 10 per cent or more below the starting level, no income payment will be made for that year.

However, when the next income payment is made, it will include the interest payment for that year, in addition to the total of all missed income payments that were not paid previously, as a result of the index being more than 10 per cent below the starting level in that year.

Again, such an investment has the potential to return nothing but the original capital, however, provided the FTSE 100 Index is not 10 per cent or more below its initial level on at least the fifth or sixth anniversaries, this structured deposit will outperform all fixed rate deposit accounts currently available.

Both products offer attractive alternative opportunities for savers who can often feel they are not getting the most from their banks and building societies.

These products become even more attractive following the Isa rule changes, which mean all the returns on deposit capital up to £15,000 could be tax-free.

As ever, if unsure about any of the avenues suitable for you, please seek financial advice from an independent financial adviser.

Christian Gardner is investment analyst at Lowes Financial Management.

Subscribe to Money Observer Magazine

Be the first to receive expert investment news and analysis of shares, funds, regions and strategies we expect to deliver top returns, plus free access to the digital issues on your desktop or via the Money Observer App.

Subscribe now

Add new comment