2.1 Variable rate and fixed rate savings products

Figure _unit2.1.1 Figure 1 Example of variable rate and fixed rate savings product over time

Show description|Hide description

This graph shows interest rate against time on a 3-year fixed rate savings product (which of course is constant across time at 5%) and an instant access variable rate savings product (which varies over time between 1% and just over 7%).

Figure 1 Example of variable rate and fixed rate savings product over time

Begin by listening to the audio, in which a young professional, Ryan, asks for help from personal finance expert Jonquil Lowe in finding his way through the many savings products on offer.

We join their conversation as Ryan asks about a savings product he’s come across called a ‘term bond’. The other savings options that are described are trackers, variable rate accounts and notice accounts.

Download this audio clip.Audio player: ou_futurelearn_mmi_aud_1030.mp3

Show transcript|Hide transcript

Transcript

RYAN

There are so many ways to save. Jonquil, I'm really not sure where to start. How about this account? It's called a 'term bond', but look, the interest rate is quite a bit higher than on the other accounts.

JONQUIL

Well, it depends when you think you'll need your money back, Ryan. Some savings products, like this term bond, lock you in for a fixed period of say, 2, 3 or 5 years. That interest rate is fixed for the full period. It often is higher than you'd get on other accounts, but the drawback is you can't usually get your money back early, or if you can there's a hefty charge such as loss of 90 days' interest.

RYAN

Right, this bond has a 3-year term, so I'd get that interest rate fixed for the whole 3 years? That's a good deal isn't it?

JONQUIL

It could be, if interest rates on other accounts stay the same or fall. But if you think interest rates will rise, you'll be locked into that fixed rate and it might not look so good after a while.

RYAN

Maybe not for me then, and look, it says that interest rate is paid out monthly. I really want an account where I can just leave my money to grow.

JONQUIL

Yes, some of these fixed term savings products pay out the interest at regular intervals, usually monthly. That's especially useful for people who need a regular income, like pensioners, but not so good for you. If your interest is re-invested, your savings will grow faster, and there'll be more to pay out at the end. That's the magic of compound interest.

RYAN

I like that, the 'magic of compound interest'. I definitely want to see my money grow, but I don't want to see myself locked into a fixed interest rate that might fall behind other accounts. What else could I look at?

JONQUIL

Have you thought about maybe a tracker account?

RYAN

A tracker account? What's that?

JONQUIL

With many accounts, the rate of interest varies when the Bank of England changes its official interest rate or 'Bank Rate' as it's known.

RYAN

Oh yes, I've heard about Bank Rate on the news.

JONQUIL

That's right. So, tracker accounts are a type of variable rate savings account.

RYAN

Variable rate?

JONQUIL

Yup. Variable rate simply means the interest rate tends to change over time. The changes are broadly in response to changes in Bank Rate, though variable savings rates are sometimes quick to fall but slow to rise. With a tracker account, there is a specific link to Bank Rate. That means if Bank Rate goes up, so does the interest rate on your account. Of course, if Bank Rate goes down, then your interest rate falls.

RYAN

And do these variable rate accounts have penalties if I want my money back?

JONQUIL

They do if they're notice accounts. So, those are accounts that typically pay a slightly higher interest rate, and you have to give the bank or building society a specified notice period for withdrawal - say 30 days or 90 days - otherwise you lose some interest, though some accounts may give you one or two penalty-free withdrawals every year. But there are plenty of instant access accounts that let you take your money out whenever you like without any penalty at all. They're especially suitable if you're looking for a home for your rainy day savings, and the market for instant access accounts is pretty competitive, so sometimes they give you a better interest rate than notice accounts anyway.

RYAN

That's all great advice, thank you so much Jonquil.

End transcript

Download

 

In addition to the products discussed in the audio, a new product, pensioner bonds, became available in 2015. The Chancellor, George Osborne, announced this new form of savings account in his 2014 Budget Statement. These first became available from January 2015 to those aged 65 years and over, with a cap on the investment of £10,000 per person per bond. Two pensioner bonds were offered: a 1-year bond offering 2.8% per annum (before tax or ‘gross’) and a 3-year bond offering 4% per annum gross. These returns, even after tax is deducted, were comfortably above the then prevailing rate of price inflation.

We looked at the impact of price inflation on investment earnings in Week 1, when we examined real interest rates. Index linked accounts are attractive to investors who want to guarantee that their savings are inflation-proofed.

In the UK, only National Savings and Investments periodically offers an inflation-proofed savings product in the form of index-linked certificates. For example, holders of the 48th issue five-year certificates are guaranteed to get their original investment (their ‘capital’) back at the end of five years with interest equal to inflation over the period plus 0.5% a year, in other words a real return of 0.5%. Someone who invested £1000 in these five-year index-linked certificates on the first date of their issue in May 2011 would, on 6 April 2016, have found that they had a valuation of £1172.80, giving a nominal return since the start of the investment of 3.3% p.a. once inflation had been added to the real return.

At times of low inflation, the return on index-linked investments can seem unattractive, but they come into their own in periods when inflation is expected to be high. Most savings products do not offer inflation-proofed returns.