The Bank of England Base Rate has been at 0.5% since 5 March 2008, generally spelling bad news for savers, especially those who rely on the income.
Aside from shopping around for a better savings account deal, there's no magical way of earning more interest - a higher income means taking risk. And if you can't afford to lose money then taking risk is probably a bad idea. But if you can afford to risk some money, or already have a portfolio of investments, then how are the main sources of income stacking up at present versus cash?
Let's take a look:
|Investment||Typical Income Yield|
|Good Inflation Protection?|
||2% - 3%
||1% - 4.5%
||Yes, if index-linked|
|Corporate Bonds (safer)
||3% - 6%
|Corporate Bonds (riskier)
||5% - 7%
||4% - 6%
||3% - 6%*
|*net of basic rate tax.|
Note: yield means income divided by the cost of the investment. So for example, if you receive £6 annual income on a £100 investment your yield would be 6%, had the investment cost £200 the yield would be 3% etc. The yield shown for gilts/bonds also includes any profit/loss if held until redemption.
Best buy savings accounts are currently paying up to 3% on variable rates, or around 4.5% if you tie-up money on a 5 year fixed rate. Rates will no doubt rise at some point, but I think it may be another year or two before we see a meaningful change. Meanwhile inflation remains a killer, leaving most savers worse off in real terms (i.e. their money, including interest, will buy less in future than today), although this could subside later in the year if the oil price settles down. The big advantage of savings accounts in this uncertain climate is safety, provided your money is fully covered by the Financial Services Compensation Scheme (FSCS) - up to £85,000 per person per institution.
Cash unit trusts (called 'money market' funds) and guaranteed income bonds (GIBs) have been competitive alternatives to savings accounts in the past. But money market funds are generally struggling to yield above 0.5% a year at present while the market for GIBs has all but dried up.
Loaning money to the Government is still fairly safe in the scheme of things, so yields (to redemption) look little better, or in some cases worse, than fixed rate savings accounts. High inflation is still a threat unless you buy index-linked gilts (where both income and the redemption price rise by inflation). The break even (relative to conventional gilts) rate of inflation (RPI) on 6 year index-linked gilts is about 2.7%, so if you believe inflation will average more than this over the next 6 years they could be worthwhile - although returns may still lag the best fixed rate savings accounts.
Lending money to companies is more risky. And the riskier the company the higher you can expect the rewards, i.e. income, to be.
For example, the redemption yield on a Unilever bond redeeming in December 2014 is currently about 2.4% - it's seen as being almost as safe as the government. A Lloyds Bank bond redeeming in March 2015 is yielding around 6.1% - suggesting investors are less confident. While Enterprise Inns (a pub chain) bonds redeeming in December 2018 are yielding 8.73% - not a great vote of confidence.
If you sell a bond before redemption you might make a profit or loss depending on its price, which tends to be affected by interest rates, inflation and the company's financial position. High inflation and interest rates are bad news, because a bond's income is fixed, and vice-versa.
The golden rule when investing in bonds is try to understand how much risk you're taking. While high yields look tempting, they're high for a reason...
Commercial property investments, such as offices, factories and shops, tend to have a good track record of paying a decent rental income. And, barring recessions, rents also tend to rise longer term, making commercial property a good antidote to inflation. However, property values can fall, as we saw clearly during the credit crunch, so you could lose money if the economy turns sour.
With rental income yields currently around 5-7%, commercial property looks fairly attractive provided you're not pessimistic about our economic outlook. Bear in mind the only practical way to invest smaller sums is via a fund - and the fund manager will often take their 1.5-2% annual charges from income, plus you'll indirectly pay around 4% in stamp duty when buying the fund (as the fund must pay this when buying UK property).
Rental yields on residential property are averaging around 4-6%. But house prices can fluctuate quite widely and easily dwarf rental returns for better or worse, so you need to be careful. Given the negative outlook for house prices and mortgages still being in short supply, rental demand is currently high - so you shouldn't struggle to rent a good property at a worthwhile rate. But as prices are expected to fall you'll need to drive a hard bargain when buying to reduce the likelihood of sitting on a loss in a year or two.
Longer term you'll probably be fine provided you project the rental income will turn a profit after all initial and ongoing costs. But I'd avoid buying to let using a mortgage - any future interest rate increases could crucify your profits.
Some dividend yields look very tempting at present, for example the Severn Trent shares dividend yield is 4.9% and it's 5.2% for AstraZeneca shares - after basic rate tax! (which can't be reclaimed). Plus companies tend to increase their dividends over time unless they're in bad shape, reducing the threat from inflation. However, share prices can be volatile, even for fairly pedestrian companies like these, so a sharp downturn in share prices could leave you sitting on a loss despite potentially attractive dividends. And there's no guarantee dividends will be as high as expected or even paid at all if a company hits hot water.
If you already own shares or stockmarket funds then taking a bias towards cash-rich high dividend companies makes sense to me in what could be a turbulent year for markets. But if you like the comfort of savings accounts I'd be very wary of jumping into stockmarkets, despite the appealing dividends on offer.
The world of investment never gives you something for nothing. If you want to beat the income from cash you'll need to risk losing money - and in the current climate markets are exceedingly difficult to predict, so the gamble is very real. While nothing to get excited about, the best savings account rates look ok given your money should be safe. If you decide to venture further afield I'd really try and take a 5-10+ year bet and ensure you're unlikely to need the money before then. While the income might be steady, it's very unlikely your capital will be.