Guide to fixed-rate bonds
- Fixed-rate bonds give certainty with regard to interest rates over the term of the bond
- No access to your money over the term, or penalties if you do withdraw
- Interest rates may be attractive when you take out the account, but you're stuck with the deal, even if rates rise
- A high minimum deposit may be required and rates may be tiered depending on how much you invest
- Consider the pros and cons of fixed-rate ISAs
Banks and building societies want you to invest your cash in their savings accounts, which is why they pay you interest.
But with a normal, easy-access account the bank or building society doesn't have any security - you can withdraw your money whenever you like.
That's why they're happy to pay a little bit more to savers using fixed-rate bonds.
These are accounts where you agree in advance not to touch your cash for a set time, typically between six months and five years.
In return for your money for a guaranteed time, the account provider guarantees you a fixed rate of interest.
That means that, whether rates fall or rise elsewhere, you'll continue to get the amount you agreed.
Who are fixed-rate bonds right for?
Think carefully before locking up your rainy-day fund in a fixed-rate bond. Some don't allow any withdrawals, while others charge a whopping penalty fee if you do take your cash out.
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Most advisers suggest keeping between three- and six-months' worth of salary saved in an easy-access account.
That way, in an emergency the money is easy to get hold of.
You can still maximise the interest you earn on that cash by comparing savings accounts and choosing a market-leading option.
But if you have some money that you can afford to lock away for a period, then it could be worth considering a fixed-rate bond.
Taking a long-term view can really help your savings grow, especially when you factor in the impact of compound interest.
How much do you need to invest?
Fixed-rate bonds are usually suitable for people with a lump sum to invest. In fact, quite often they have a high minimum amount needed to open an account.
It's typically between £1,000 and £2,000, and there may be a maximum deposit, perhaps £500,000. Check the small print on your paperwork to make sure it's suitable for you.
Sometimes, the rate of interest you can earn from this sort of product is tiered, so it rises depending on the amount in the account.
What are the risks?
Placing your cash in a fixed-rate bond isn't as risky as investing in stocks and shares. After all, your balance can't go down.
But that doesn't mean that there aren't risks. When you agree to a fixed rate for a set period, you're stuck with it.
And that means that if the market changes and average interest rates go up, you could be left trapped in an uncompetitive deal.
When comparing fixed-rate bonds you need to consider both the rate the account pays and how long it lasts. Find a balance that you're comfortable with.
A fixed-rate ISA is one way to use your tax-free allowance in a year. Subject to the risks noted above, if such an account is paying more than an easy-access option it may be a way to get more benefit from your tax-free savings.
Remember that you can only open one Cash ISA in a given financial year, but you can then transfer it into another ISA account, perhaps one offering better returns.
As with a regular fixed-rate bond, if you're taking out a fixed-rate ISA think about the length of time you're committing your money for and what might happen to interest rates in that period.
Protecting your nest egg
Savings providers are authorised and regulated by the Financial Conduct Authority † in the UK and any money that you deposit with them is protected by the Financial Services Compensation Scheme (FSCS).
The FSCS is a compensation fund that offers protection in the event of an authorised firm becoming insolvent or ceasing trading.
A bond of this type is really a fixed-term loan from you to the provider (the bond issuer), usually in return for a higher interest rate than you may get from traditional deposit accounts
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What are the alternatives?
If you don't want to put your money completely out of reach for six months or more, there are other options.
As a general rule, the more restrictions a savings account comes with, the higher the interest rate, but you may find an attractive return through a high-interest current account.
You could also earn a decent return on a regular saver account, where you agree to pay a minimum amount in each month.
Some easy-access accounts restrict the number of withdrawals you can make in any one year and pay a higher rate of interest as a result.
Peer-to-peer lenders have a variety of fixed-rate options to consider, but remember that this will be a riskier investment than a regular savings account and P2P savings don't fall under the FSCS compensation scheme.
From April 2016 you will, though, be able to place peer-to-peer bonds within a tax-free wrapper by using an Innovative Finance ISA.