Interest rates on cash accounts have not produced great yields in recent years. But choose the right platform and you can sow the seeds to make your money flourish
Interest rates on cash accounts do little to encourage you to save and aren’t much help if you’re trying to generate an income from your savings either. Put £10,000 in an account paying 1% interest for a year and you’ll only be rewarded with £100. However, for savvy savers and even savvier investors, there are ways to make your money work harder.
How: Instant access savings account (1.5% for top-paying cash Isas).
What you need to know: After current accounts, easy access accounts typically pay the lowest interest rates of all cash accounts.
This means that it’s even more crucial that you shop around for the highest rate and use Isas to spare you any tax that may be payable on your interest.
The Moneywise view: These accounts are great for rainy day funds but shouldn’t be a home for your life savings.
Rates are low and may not even keep pace with inflation. So, even though you won’t physically lose money with this type of cash account, there’s a very real risk that over the long term its value will reduce in real terms – that is, its spending power will be reduced.
Top buys: Coventry Building Society’s Easy Access Isa pays 1.5% (including 0.32% bonus to 31st August 2020). Virgin Money’s Double Take E-Isa Issue 6 pays the same rate (without the short-term bonus) but you’re limited to two withdrawals a year.
How: Premium Bonds. NS&I pays out 1.4% interest in prize money, but only winners receive something, so it depends on your luck.
What you need to know: The UK’s favourite savings product, premium bonds, do not pay interest, but each month your bonds (which cost £1 each) are entered into a draw with prizes from £25 to £1 million. Prizes are paid tax-free and deposits are 100% protected by the government. For each bond the odds of winning a prize are 24,500 to one.
The Moneywise view: NS&I, which sells the bonds, quotes an annual prize fund interest rate of 1.4% – but this is an arbitrary figure. Your returns will ultimately come down to whether you win and if so, how big. For this reason, premium bonds shouldn’t be a core part of your savings strategy. However, the prize draw element makes them a bit more interesting than a common-or-garden savings account, so if you have money to spare they may be worth a token punt.
Visit nsandi.com/premium-bonds for more information and to buy.
How: Fixed-term savings account, (the best five-year rate is 2.1%).
What you need to know: Tying your money up for a fixed period will increase the amount of interest your savings provider pays, and the longer you fix for, the higher the rate you’ll get. Terms start at 12 months and rise to five years.
The Moneywise view: Fixing will earn you the best rates on your cash holdings, just make sure you can afford to leave the money untouched for the required period. You should also consider how likely it is for interest rates to rise before you lock into longer-term fixes. Again, bear in mind the impact of inflation on your cash – if you can afford to tie up some money for five years it may also be worth considering equity-based investments for potentially higher returns (see box top right).
Top buys: Metro Bank and Coventry Building Society are both paying 2.1% on their five-year fixed-rate Isas. Aldermore pays 1.9% on its three-year fixed-rate Isa, while for one year the best rate is 1.61% from either Al Rayan Bank or the Family Building Society.
How: P2P Lending.
What you need to know: Lending money to others via peer-to-peer platforms such as Zopa and Ratesetter should pay you a better rate than you will be able to achieve with a savings account. However, returns are not guaranteed and your cash is not protected by the Financial Services Compensation Scheme. The rates you’re offered will depend on the risk profile of the borrower/s you are lending to and the duration of the loan. Higher rates can be achieved with platforms such as Funding Circle, which lend to businesses rather than individuals. However, this is considered higher risk.
The Moneywise view: Peer-to-peer lending should give you a better return but it’s vital lenders/investors are aware of what will happen if borrowers default on their loan. Each platform has its own way of mitigating this risk. Zopa spreads your investment across multiple loans and factors anticipated defaults into its targeted returns.
Ratesetter, meanwhile, has a provision fund to protect its investors. Do your research before you invest and make sure you understand how your chosen platform works first.
Top buys: Zopa, which won most trusted P2P platform in the Moneywise Customer Service Awards this year, targets returns of 4.5% a year, rising to 5.2% if you are prepared to lend to individuals with a lower credit rating. Ratesetter pays 3% if you need instant access to your cash, 3.9% if you commit for a year, or 5.1% on the five-year market. Lending Works, which this year won best P2P platform for investors in our awards, offers 6.5% over five years.
How: Fixed interest.
What you need to know: This asset class traditionally sits between cash and equities in terms of risk and involves lending money to governments (gilts) or companies (corporate bonds) in return for a fixed-rate of interest.
Yields are based on the risk of the borrower defaulting on their loan, the higher the risk the greater the potential yield. Patrick Connolly, chartered financial planner at Chase De Vere, says: “Fixed interest can provide a steady income stream and should provide good capital security."
“However, many fixed-interest assets look expensive and they could fall in value if interest rates rise,” concludes Mr Connolly.
The Moneywise view: It’s best to buy bonds as part of a collective bond fund where a manager will buy and sell the best opportunities on your behalf. Bonds are affected by changes with inflation and interest rates – it may be best now to go for a strategic bond fund. These give managers more freedoms as to where they invest and makes them better placed than more restricted funds in a low-interest environment. Investors, however, need to be mindful that they may be higher risk as a result. Also decide whether income or capital protection is more important to you as some managers will prioritise one over the other. So, for example, some managers will put capital at greater risk to drive a higher income, while others will be prepared to reduce the income produced by the fund to protect investors’ underlying capital.
Top buys: Jupiter Strategic Income is a flexible ‘go-anywhere’ bond that seeks high income and capital growth by investing in a global range of fixed interest securities. Royal London Sterling Extra Yield is another above-average risk option. However, its performance has been consistent and it won the best strategic bond fund category in the Moneywise Fund Awards 2018.
Stepping up to equities
If you have savings that you will not need to access over the next five to 10 years it makes sense to consider moving money out of cash and into equities. Returns can be accessed to top up your income or reinvested for growth. Investing for the first time can be nerve-wracking but it doesn’t have to be. Online investment platforms allow you to open Stocks and Shares Isas that protect your savings from tax and offer a wide range of funds and investment trusts into which you can save.
To make the decisions easier Moneywise First 50 (https://www.moneywise.co.uk/moneywise-first-50-funds) offers a list of recommended investments including lower cost passive funds and actively managed options. Alternatively, some platforms offer recommended fund lists such as interactive investor’s Super 60 and ready-made or model portfolios.
For full advice and recommendations based on your specific circumstances it’s worth consulting an independent financial adviser.
How: Commercial property.
What you need to know: Commercial property fund managers build portfolios of properties including offices, warehouses, retail and entertainment outlets. Monthly rent payments provide investors with a reliable income stream. They are often used by investors to add diversity to a portfolio. It is also important to note that some funds invest in property company shares rather than purchasing properties directly – these funds will have a greater correlation with equities.
The Moneywise view: “Property has been a traditional source of income, but with high street retailers and the town centres in which they predominate dying a slow death from a thousand Amazon deliveries, investors need to be very careful when selecting commercial property funds that they are sufficiently diversified in terms of their underlying risks,” says Rebecca O’Keeffe, head of investment at Moneywise’s parent company, interactive investor.
It’s also worth considering the type of vehicle you use – open-ended funds can suffer liquidity problems and managers may have to sell quality holdings if too many investors want to access their money. This forced many funds to temporarily suspend trading as a result of large withdrawals made after both the financial crisis in 2008 and the EU referendum in 2016. The closed-ended nature of investment trusts means their managers do not face the same pressures.
Top buys: Picton Property Income, managed by Michael Morris, won the award for best direct property trust UK in the Moneywise Investment Trust Awards 2018.
How: UK Equity Income.
What you need to know: Funds in this sector focus on companies paying strong dividends.
It’s a huge sector, says Ms O’Keeffe, so there is plenty of choice for investors. “From actively managed options through to low-cost trackers, investors can choose what style of manager they want and what yield they are targeting,” she says. “Many managers aim to select companies that can consistently support a growing and sustainable dividend.”
Juliet Schooling, research director at Chelsea Financial Services, adds. “You also need to pay attention to whether you want a high yield today or a growing yield tomorrow.”
The Moneywise view: Income-seekers should also consider equity income investment trusts. Trusts are able to hold back 15% of their income during strong years to help them deliver a rising income over time. Some trusts have excellent track records for increasing dividends over time, including City of London, Bankers and Alliance, which have increased dividends for an impressive 52 consecutive years. Whether you go for a fund or trust, equity income shouldn’t be income investors' preserve. Reinvesting dividends can be great for driving capital growth.
Top buys: Franklin UK Rising Dividends is one of Moneywise’s First 50 Funds. It is a concentrated portfolio – typically with 40-50 stocks – and focuses on funds with a strong track record of rising dividends.
Also featured in Moneywise’s list of recommended funds for new investors is the aforementioned City of London Investment Trust.
It is a lower-risk trust with a cautious investment style.
Thrills without the spills: Understanding investment risk
When you invest in the stock market there is always the risk that the value of your investments will fall at some point. However, over the longer term, equities should give you greater returns than cash and make it easier for you to reach your savings goals. Figures from Hargreaves Lansdown show that if you had put £1,000 into the average savings account in 2009, you would have just £1,139 for your efforts. However, had you put that money into the L&G UK Index Tracker you would be sitting on a pot worth £2,450. The key is to take calculated risks and manage your investments sensibly.
This means not putting all your eggs into one basket. By diversifying your money across a range of different investments – some in equities, some in cash and some in bonds – you reduce the risk of one investment performing badly and taking a serious chunk out of your savings.
It’s also important to think about the long term and not get too caught up in the daily ups and downs of stock market investments. Short-term losses are often recouped over time.
How: Overseas Equity Income
What you need to know: Our experts agree there is a strong argument for holding overseas equity income funds too.
“Around 50% of UK dividends are paid by a handful of companies and if one – like Vodafone, recently – cuts the dividend it can have a big impact. So investors may like to look abroad for diversification,” suggests Ms Schooling.
According to the Janus Henderson Global Dividend Index, global dividends are twice as high as they were 10 years ago.
The Moneywise view: Diversification is key to successful investing, but investors do need to be mindful of specific regional risks. Ms Schooling points out that the Asia Pacific ex-Japan region has shown the highest level of dividend growth in the past decade as profits have risen and corporate governance improved.
However, it’s a riskier proposition than an investment in a more developed region. Investors also need to be aware of currency risk, which could reduce returns.
Top buys: For investors who are willing to take more risk, Ms Schooling likes Schroder Asian Income. She also rates Blackrock Continental European Income. For more diversified global exposure with a bias towards more developed economies, consider Fidelity Global Dividends, which features in interactive investor’s Super 60 list of recommended funds.
Income funds aren’t just for income investors
“Albert Einstein reportedly called compound interest the eighth wonder of the world, illustrating that he had as good a grasp of personal finance and savvy investment acumen as he did of theoretical physics. According to websites such as CelebrityNetWorth, Einstein was worth $1 million upon his death,” says Moira O’Neill, head of personal finance at interactive investor. “So, it’s no surprise to see that Einstein’s views on compound interest are as apt today as ever. With dividends reinvested, the FTSE All Share is up 149% over the past decade, compared to 74% if you had decided to take the income.
“Likewise, the FTSE World Index is up 236% with income reinvested compared to 160% if you had taken the income and gone for instant, rather than delayed, gratification. Reinvesting dividends means that more money is working hard for you – it is a significant driver of long-term returns.”
If you'd like to reinvest your income from your funds, pick accumulation rather than income shares – referred to as inc or acc on your investment platform.