Deposits that can beat the base rate
5 October 2017
With most cash accounts making below inflation payouts, structured deposits can offer a higher return alternative, suggests Ian Lowes, found of StructedProductReview.com and managing director of Lowes Financial Management.
With approximately £700bn held in savings accounts across the UK, over half of which lies in easy-access savings accounts, the average saver certainly isn’t getting the best out of their cash. The highest savings account rates now stand at 1.25% for instant-access and 2.5% for five-year, fixed rate bonds yet, in the context of the Bank of England Base Rate, which is currently 0.25%, but could be set for a slight increase, even these rates seem very generous. Many banks offer enticing, introductory rates, or incentives which may not last long but even with these at their maximum levels, the real rate of return on virtually any deposit-based savings is likely to be negative after tax and inflation.
With the interest rates on savings accounts at such low levels many savers now see the interest paid on their accounts as almost insignificant, many of whom don’t know what interest rate/s they are receiving and this can have a significant impact on the purchasing power of their savings in the future.
Structured deposits as an alternative
From our own maturity data for 2016, we can see that, out of 101 maturing structured deposits, the average interest earned at maturity equated to 3.25% per annum, with the best 25 returning on average more than 6%.
When we look at the 71 maturing deposits linked solely to the FTSE 100 Index, 67 produced positive returns with the average interest payment equivalent to 3.72% pa. This, in comparison to what the high street offered is impressive and has meant that the capital has kept pace with and beaten inflation.
Structured deposits do not offer a fixed rate of interest each year, but instead provide a potential interest payment, typically at the end of the term, based on the performance of an underlying measurement, such as the FTSE 100 Index. The combination of capital protection and participation in the rise in the index gives investors the opportunity to receive higher returns than could be achieved through a traditional savings account. The terms of these deposits are determined before investment, with some including opportunities for early maturity and/or a defensive feature, which is where the underlying index can fall from its Initial Index Level and still provide an interest payment.
One deposit currently available for investors is the Investec FTSE 100 Kick-Out Deposit Plan 72 – Option 2, which is ‘Preferred’ by Lowes. It has an 8-year maximum term with the opportunity to mature on any anniversary from 4 years onwards, returning capital plus an interest payment of 4.5% for each year held which will be achieved if the FTSE 100 rises by any amount. We feel that in the context of the capital protection offered, as it is a deposit, the potential for 4.5% per year interest payments, payable from year 4 onwards is an attractive proposition. On balance, we feel this offers a reasonable return for deposit- based product and could be used together within a portfolio or as part of a spread of other deposits.
Structured deposits have the benefit of capital protection, so even if it does not produce an interest payment because the stock market isn’t higher on any relevant annual observation date, the original capital will be returned at maturity, regardless of the extent of the fall in the FTSE 100 Index over the term. Structured deposits are also covered by the Financial Services Compensation Scheme (FSCS), which has recently increased its protection limit. This means that even if the bank defaults during the term, investors should benefit from cover of up to £85,000.
It should, of course, be acknowledged that whilst capital protection means that the original capital is safe, its real value could be depleted by inflation, particularly over an eight-year period when, additionally, the risk that interest rates could and probably will rise, needs to be recognised.
Whilst it is clear that some alternative risks need to be accepted, compared to alternative fixed term, fixed rate deposit, structured deposits only risk the interest that would have otherwise been earned. So, for those looking to get the most out of their savings, while diversifying their exposure to various banks, these vehicles could provide a suitable alternative.
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