Ian Lowes, founder of CompareStructuredProducts.com - 24/05/2016
It’s been 7 years since the Bank of England slashed its base rate to 0.5% and since then hopes of rate rises have been consistently dashed. Recently, the situation has worsened with National Savings & Investments as well as major banks announcing forthcoming cuts, rather than increases, to the interest paid on many accounts, some by as much by 50%. This has dealt another damaging blow to savers needing a safe, but rewarding home for their cash.
Inflation is a growing risk to investment returns and according to Bank of England governor Mark Carney, it may become a bigger issue going forward. He recently suggested that Britain leaving the EU could result in inflation rising 1.5 percentage points after two to three years, as investment, consumption, exports and supply could all be hit. He also suggested there may be an interest rate cut if Britain leaves the EU.
So what do investors do with their cash? If you need it to grow in real terms, it’s likely that some alternative risk beyond deposit accounts will need to be taken on. Whilst historically, diversified portfolios of shares and many other investments have, in most cases of medium to long-term timeframes, outperformed cash investments, they by their very nature could result in an unfavourable outcome. For those who don’t want to risk their capital, sticking to the traditional options of savings accounts, leaves them having to accept low interest rates which, in the case of many accounts, is hardly worth having at all.
For those who are prepared to lock up the capital for a fixed term, there have always been higher rates on offer. At the time of writing, a five-year fixed term deposit offers as much as 2.25% per annum. Whilst it needs to be accepted that interest rates could rise over the fixed term period, based on the rates typically being paid on instant access cash accounts, this might not seem like such a bad deal.
But what if you were prepared to sacrifice the meagre interest paid on most accounts in return for hopefully achieving much more, but still without risking original capital?
One option might be Premium Bonds. If you have no luck, you will still have your original capital when you cash in your holding, although remember its spending power will have been eroded by the effect of inflation. If you have average luck, you will earn 1.25% but if you have exceptional luck, you could earn as much as £1,000,000 on as little as a £100 holding, although this is very, very unlikely.
An alternative that we at Lowes Financial Management utilise alongside instant access accounts and sometimes Premium Bonds are structured deposits. Like Premium Bonds, the net result could just be a return of capital, with no interest, but structured deposits can produce much higher returns than fixed term deposit accounts, without the individual needing luck, whilst providing the same protection against the bank failing.
One structured deposit that has been granted Lowes “Preferred” status is the Hartmoor FTSE 100 Deposit Growth Plan 4. This 6-year deposit offers just short of 5% per annum, compound return, being an interest payment of 34% at maturity if the FTSE 100 Index is at or above the closing level of the Index on 13 June this year.
Whilst predicting a rise in the FTSE may be potentially a little more scientific that predicting a Premium Bond win, it needs to be appreciated again, without the requisite luck, or in this case, the FTSE 100 being higher at the end of the 6 years, the Hartmoor Plan will just return the original capital with no interest. When considering the interest that would otherwise have been earned and would be given up, this may not be too high a price. Before investing, you must be prepared to lock your capital away for 6 years.
The deposit taker for the Hartmoor structured deposit is the challenger bank, Aldermore which is covered by the UK’s deposit guarantee scheme, the Financial Services Compensation Scheme, providing protection for eligible deposits of up to £75,000. An equivalent 5 year fixed rate bond from this bank pays 2.25%.
Another structured deposit with the same term and similar criteria, but alternative bank, offers a total interest payment of 28% rather than 34%, but the crucial difference is that the FTSE 100 needs to be above 95% of its start level at the end of 6 years, rather than above 100%.
Whilst it is clear that to produce better returns some alternative risks need to be accepted, structured deposits only risk the interest that would otherwise have been earned on a fixed term deposit and not the capital. They are potentially a suitable alternative for those looking to get the most out of a moderate savings portfolio as well as those with significant funds looking to diversify their exposure to various banks and enhance potential returns.
A version of this article first appeared on WhatInvestment.co.uk.