Ask Justin

Asked by anantgholkar, submitted 29 August 2010.

Is investing in the Natwest fixed rate bond issue 221 a good idea?

Answered by Justin on 31 August 2010

This is a three year savings account that pays interest of 1.98% p.a. in year 1, 3.93% in year 2 and 5.84% in year 3. You can withdraw your money before maturity, but you’ll be charged a rather penal 270 days of interest.

The interest, paid monthly, must be credited to a Natwest current account or instant access savings account, which risks you earning very little subsequent interest unless you move the money elsewhere. Natwest will also only pay the Bank of England base rate, currently 0.5%, on money put into the bond until the start date of 18 October 2018.

These so-called ‘stepped rate’ bonds are a bit of marketing gimmick as they’re really just a fixed rate bond offering a rate equal to the average paid over the term. Banks like them as it means they can highlight very high interest rates when promoting the account, even though these rates will only be paid in the latter years.

This Natwest bond pays an average annual fixed rate of 3.92% over the three year term, which is reasonable but you can earn more elsewhere:

ICICI Bank pays 4.15% (4.08% monthly interest) on its HiSave 3 year fixed rate bond, although withdrawals are not allowed. And the AA offers a competitive 4.10% (4.02% monthly interest) on its 3 year fixed rate bond, which allows withdrawals (albeit with up to 270 day’s loss of interest).

As for investing in fixed rate savings accounts more generally, I think they’ll probably fare well versus a variable rate account over the next 2-3 years. The ‘best buy’ fixed rates offered are currently somewhat higher than the most competitive easy access accounts and I doubt interest rates will rise by much, if anything, over the next the couple of years. But you’ll need to be comfortable tying up the money, as it may be expensive or impossible to get your hands on it before maturity.