Money news, advice and predictions for savers and spenders. This week: what savers should do when interest rates fall through the floor.
By Jeremy Gates
When the Bank of England announced the lowest interest rates in its 314-year history this week, millions of savers must have wondered why they are carrying the can for the excesses of bankers kept in highly-paid jobs by taxpayer handouts.
Borrowers are puzzled too. Even before this latest cut, Andrew Hagger at financial website Moneynet.co.uk found that while the rates paid to savers have been shredded, rates on personal loans, credit card purchases and authorised overdrafts have all risen since January 2008.
"We have a situation where 210 variable rate savings accounts pay 0.5% or less, out of a total of 501 - and some savings rates may be virtually wiped out by the latest cut," says Hagger.
"If you have some spare money and can afford to lock it away, lock into a decent rate like Nationwide's ISA Bond paying 4.25% over three years on minimum £1 deposits, or 4% over two years.
"Otherwise, rates are only going one way, for the moment."
Some 18m savers pay tax on bank and building society interest and the National Pensioners Convention thinks five million pensioners rely on savings to generate half their income.
Longer term savers, with money tied up for longer periods in the tax shelter of ISAs (Individual Savings Accounts) are among the hardest hit: five ISAs now pay less than 1%, including a Halifax account paying 0.15% up to £3,000, and the average of 212 cash ISAs is just 2.4%.
Savers with a minimum £25,000 to put away still get 4.6% gross at the Investec High 5 account.
Geoff Tresman, chairman of financial advisor Punter Southall says savers could find themselves in a position where banks and building societies hold their money, but pay no interest.
"This effectively is zero return. The next step is where banks hold depositors' money, offering zero return, in return for a charge. Effectively, that's a negative rate of interest."
Politicians clearly see the groundswell of anger.
Opposition leader David Cameron wants to abolish income tax on basic rate taxpayers' savings. There are hints that Government might raise the current annual limit on ISAs, to put more earnings on savings beyond the taxman's grasp.
Will savers just give up and go on spending sprees?
Probably not. Their habit is so deeply ingrained that savers keep stashing cash, possibly fearing even worse is just around the corner.
In the mid-1970s, inflation approached 20% after the miners won a big pay battle. Savings rates, if memory serves me rightly, were nowhere near double figures, and yet savers kept merrily saving away.
I expect no great drop in the flow of cash into Premium Bonds in 2009, even with prize money at a measly 1.8%. National Savings & Investments (NS&I) has Government backing to guarantee 100% of all funds it holds.
Even in freaky 2009, however, savers shouldn't be too downhearted for several reasons.
Firstly, rates have to return to sensible levels at some stage. In a new age of austerity, how else will banks and building societies rebuild broken balance sheets?
Patient savers might have to spend more time finding better-paying accounts.
Before this latest cut, savers locking up money for at least one year could earn 4.5%-plus with providers like ICICI Bank and Anglo-Irish Bank, while Close Brothers was inviting final subscriptions - at least £10,000 - to a Premium Gold Account paying 5% gross for two years, fully covered by the Government's compensation scheme.
Abbey's Fixed Rate Monthly Saver promises a minimum 5% AER to savers paying in £20-£250 per month, by standing order, over a 12-month period.
Savers taking out a regular investment, pension or personal protection plan with Abbey after a year of saving earn 7% AER.
The second advantage for savers is that they have muscle to haggle deals - typically on cars, building work, holidays - if recession bites deeply.
In London, tenants are getting sizeable reductions by paying a year's rent in advance. Landlords like cash upfront, and hope tenants move before the year is up.
Thirdly, and perhaps most importantly, savers have a freedom to plan a financial strategy which few others will enjoy in difficult months to come.
Brian Dennehy, at financial advisor Dennehy Weller, thinks plunging rates could see savers re-evaluating risk.
"The stock market peaked 10 years ago, and since then, many savers have made a firm decision to avoid any risk. Many portfolios became massively overweight in cash," he says.
Now he sees a willingness to switch from low-paying savings accounts into two types of managed funds.
Equity income funds hold shares in companies paying good dividends while corporate bond funds hold bonds offered by private companies to raise funds.
Both offer better than most savers will see from banks and building societies for some time. But neither guarantees all money invested can always be withdrawn without capital loss.
"Look at the history of the M&G Dividend Fund since the mid-1960s and you see dividend generation by equity income funds has a long track record of stability," says Dennehy.
This is what investors like about equity income funds. However, UK equity income funds had a grim 2008, falling around 30% in value as London shares collapsed.
The Dennehy Weller monitoring service also found 27% of income funds cut dividends in November, and more cuts must be expected in 2009.
However, Dennehy points out that the number of leading FTSE100 companies paying dividends of 5%-plus is quite high, and although some funds might have to cut, it is unlikely to be anything like falls seen in savings rates.
"A well-constructed equity income funds might cut its yield from 6% to 5%. That's music to the ears of many savers seeing rates massacred," he says.
For equity income funds, Dennehy Weller tips Newton High Income and Liontrust First Income - judged on their yield and track record.
Corporate bond funds see less capital growth and actually fell around 10% in 2008, in a bond sell-off possibly led by hedge funds needing to repay investors.
Dennehy says many sophisticated investors see corporate bonds as lower risk, and likely to recover first from recession.
"When companies fail, bonds are worthless. But strong funds might hold 200 bonds, so failures are absorbed by the rest perfoming well."
Financial advisors see an increasing appeal in European and even global equity income funds as added protection against the pains which UK companies might suffer in the next 18 months.
Rob Pemberton at wealth manager HFM Columbus says it is important to understand the risk element in corporate bonds.
"Investing in them is a straightforward business as you are essentially asking just two questions: will I get my money back and what rate of interest will I be paid? The greater the risk of not being repaid, the higher the income yield."
Pemberton advises clients to go for the long-established funds dealing in more secure investment grade bonds; he likes M&G Corporate Bond Fund, which returned 7.1% in the year to November 1, and also tips Invesco Per-petual's Corporate Bond Fund and the marginally riskier Artemis Strategic Bond Fund, currently yielding nearly 8%.
Equity income funds and corporate bond funds can be held within an ISA wrapper,and as rates on cash crumble, there may be a case this year for using the £7,200 individual ISA allowance on a managed fund, for investors ready to accept higher risk.
:: INFORMATION: HFM Columbus (01932 870 000); Dennehy Weller (0208 467 1666); Abbey (0800 234 6065).
POUNDNOTES
:: The latest rate cut is good news for Brits heading for the ski slopes and other destinations abroad because it should strengthen the pound against other currencies, say the experts. Nick Fullerton at FC Exchange sees the 50 basis point cut as "brilliant news for Sterling, and after coming near to parity with the Euro, the pound has veered away and is now gaining ground."
Stephen Heath at FairFX.com is equally bullish: "The pound can be expected to claw back further gains in the coming months as Europe and America start to look vulnerable as rival economies," he says.
Another currency supplier, ICE, says strongest demand in December was for Euros, up 38% on December 2007. The US dollar was in second place, while the Aussie dollar saw a 40% surge in orders during December.
:: The most competitive mortgage lender in 2008 was HSBC, according to mform.co.uk, a unique service linking mortgage customers directly to the application systems of lenders.
In second place with mform.co.uk was Yorkshire BS, with smaller regional societies including Newcastle, Furness, Tipton and Mansfield all in the Top Ten with the C&G subsidiary of Lloyds TSB. HBOS-owned Halifax, soon to become part of Lloyds TSB, also made the top 10.
HSBC will pass on the latest 0.5% rate cut by the Bank of England to all mortgage and commercial borrowers, meaning its standard variable rate falls to 3.94%. Demand remains strong for HSBC's lifetime tracker mortgage, changing 1.95% above Bank of England base rate (currently 3.44%).
:: Don't go into the red on your bank account in the gap between your pre-Christmas and January paydays, says Andrew Hagger at www.Moneynet.co.uk. He reckons that if a bank pays an item for £100 which takes a customer into an unauthorised overdraft, bank fees and interest could cost over £120 if the debt isn't cleared within seven days.
If a bank agrees to pay an item instead of returning it unpaid, and the customer fails to bring the account back into the black or within an agreed limit for seven days, then charges could range from £41.98 on a Nationwide Flex account to £120.32 on a Lloyds TSB Classic Plus.
:: Not all insurers are scratching around for cash. Large rural insurer NFU Mutual has confirmed a bonus for loyal customers for the 10th year running. In 2009, as in previous years, it's general insurance customers that can expect a bonus of up to 10% of their premiums when they renew their policies, making total bonuses for 2009 worth around £85m.
:: HIGH FIVE SAVERS:
Phone No Rate Account Period Deposit Interest paid
ICICI Bank UK www.icicibank.co.uk 5.10% (F) HiSAVE Fixed Rate 12 Month Bond £1,000 OM
Close Brothers 0207 392 1772 Premium Gold 2 Two year Bond (B) £10,000 Yly
West Bromwich BS 0845 330 0622 4.75% High Income Over 65 90 Day (D) £5,000 Mly
Anglo Irish Bank 0845 455 2222 4.60% (F) Fixed Rate Bond 1 Year Bond (B) £500 OM
Market Harboro' BS www.mhbsonthedot.com 4.55% onthedot 30 day 30 Days £1 Yly
:: TOP FIVE BORROWERS:
Phone No Rate Period Max% Adv Fee Incentive
First Direct 0845 610 0100 3.89% for term 80% £799 Yes
HSBC 0800 494 999 3.95% for term 60% £799 Yes
Co-Op Bank 0800 633 5286 4.14% to 31/3/12 75% £995 Yes
Mansfield BS 01623 676 345 4.49% for two years 75% £599 Yes
Yorkshire Bank 0800 202 122 4.49% to 31/3/11 75% £599
Code:
*F - Fixed
*P - Operated by Post
*B - Operated by Post/Telephone
*T- Operated by Telephone
*W- Operated by Internet
*H- Operated by Internet/Telephone
*S- Available only to those aged 50 or over
*R- Available to those aged 60 and over.
:: Source: Money£acts - Tel: 01603 476 476 (All rates subject to change without notice)
