I'd use peer-to-peer lending to beat the banks
Hunting down attractive income in today’s low interest rate environment is akin to looking for a needle in a haystack.
Although a handful of banks and building societies have tickled up savings rates since the turn of the year, rates of 0.01% are still more common than those above 1%.
Without an increase in base rate, which admittedly could be on the cards sooner rather than later, savers must accept that income will remain scarce.
Even dividends from investing in stock-market listed companies are under pressure as corporate earnings are impacted by a weak pound.
For investors, this downward pressure on dividends can be mitigated by holding an investment trust with big reserves of income in its tank – income earned in previous years but not yet paid out to shareholders. By drawing on these reserves in the diffi cult years, some investment trusts have managed to increase their dividend payments for more than 30 consecutive years. Yet, impressive though such income records are, investment trusts are not for the risk averse.
One relatively new source of income for savers has come from the burgeoning ‘peer-to-peer’ (P2P) lending market, where institutions bring together savers and borrowers. In general terms, the money lent by savers is used to provide fi nance for expanding businesses.
The interest that the borrowers pay on their loans helps towards providing savers with an income on the money they have lent out. In terms of risk, it sits somewhere between the cast-iron guarantees that underpin deposit accounts (namely, security of capital and statutory protection up to £75,000 per financial firm from the Financial Services Compensation Scheme in the event of a bank’s collapse) and the volatility of shares. But in terms of income opportunity, it beats both deposits and shares.
This growing market, which is now regulated, is dominated by three players – Funding Circle, RateSetter and Zopa. The annual interest on offer varies, ranging from 2.9% (RateSetter) through to in excess of 7% (Funding Circle), but so does the degree of risk you will take.
While the 2.9% interest on offer from RateSetter comes with the backing of a ‘provision fund’ (designed to protect your capital from losses if loans turn bad), the 7% from Funding Circle has no such underpin. If a loan goes bad, your capital could be compromised.
Four and a half years ago, when peer-to-peer lending was beginning to grab savers’ attention, I decided to test it out. I invested £200 through Funding Circle. I feared the worst – as befi ts a cynical journalist – but I have been pleasantly surprised. My latest statement
informs me that my £200 has grown to £257.56. The £57.56 of added value comprises £82.89 of income, denuded by £9.41 of (Funding Circle) fees and £15.92 of losses.
All in all, it’s an annual return (after fees but before tax) equivalent to a shade above 6%. That’s far better than I would have done if I had put my money in a deposit account, but not as sexy a return as I could have got in an investment trust investing in the UK stock market. For example, if I had put my £200 in The City of London Investment Trust, a member of Moneywise’s First 50 Funds, it would now be worth £340.
My peer-to-peer money is spread across 16 businesses operating in everything from retail through to IT. It is effectively an investment play on UK plc. When the economy is strong, my companies are more than likely to keep repaying the loans they have secured.
As someone who is still working and not in need of savings income, I will not be committing more funds to Funding Circle. But if I were looking for alternatives to cash, peer-to-peer is certainly an option I would consider.
Especially when the big three get regulatory clearance to launch innovative fi nance Isas (peer-to-peer individual savings accounts) in the spring, then enabling all returns to be tax-free. Of course, as with any fi nancial product, you need to ensure that you end up with the right lender (stick to the big three). You must also understand the risks and all the fees involved. But mark my words, peer-to-peer lending is here to stay.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.