One of the questions we are frequently asked by clients is whether they should opt for a fixed rate deposit account for their cash savings or choose the easy access option.
If they do fix, for how long should they fix – one, three or five years?
The economics behind the numbers are usually quite simple; fix for longer and benefit from a higher rate of interest.
Taking a look at the most competitive rates available to UK savers from mainstream banks and building societies today, we see that instant access is paying 1.70% (including a 1.19% bonus for twelve months).
A one year fixed rate bond is paying slightly more interest, at 2.00%. Two years will get you 2.30% and three years will pay 2.45%.
All of these interest rates are of course subject to income tax. Once tax and inflation is taken into account, savers are likely to experience a real terms loss in the value of their capital, regardless of whether they opt for easy access or fixed rates.
If you are prepared to fix your savings interest rate for longer than three years, a five year bond is offering 3.00%.
I was recently quoted in the Mail on Sunday saying it would be madness to lock up your savings for five years or longer. With interest rates currently so low, there is a real chance they will go up during a five year fixed period, leaving savers with a less than competitive deal.
Our view is that most savers can benefit from fixing for a year, possibly two.
Before tying up your cash savings for this long, you might consider holding some money back as an emergency fund with easy access.
Savers also need to consider the tax implications of their savings strategies today more than ever before, in order to maximise returns.
Making use of your cash ISA allowance means your interest on cash savings within the ISA is free of income tax.
You can get 2.25% tax-free interest from the most competitive easy access cash ISA right now, beating the net interest from a three year fixed savings account for basic and higher rate taxpayers.
Fixing your cash ISA for a year only gives you 2.20%, making the easy access route more attractive. Two years gets you 2.55%, which might be worth considering if you believe interest rates are destined to stay low for at least the next couple of years.
The markets indicate interest rates will stay low until at least 2016.
With the latest Monetary Policy Committee minutes out this morning showing that Bank governor Sir Mervyn King voted again for an additional £25bn of quantitative easing, we expect interest rates to stay low for at least that long.
