Want to beat low savings rates? Become an investor

Pensioners have been saved from low interest rates by a new bond launch from NS&I but for younger savers, the only chance of a decent return is to become an investor.

Government figures show that disillusioned savers are already opting for investing though individual savings accounts (ISAs). The number of cash ISAs fell by 1.2 million last year while the number of people subscribing to a stocks and shares ISAs increased by 3 million. On top of this, the £470 billion held in ISAs was split almost evenly between cash and stocks and shares.

This shift is unsurprising considering the persistently low interest rates that savers have endured in the past few years. Over the past 12 months alone, the average interest paid on a cash ISA has fallen to 1.45% from 1.64% the previous year.

While inflation is currently at an historic low of 0.5% meaning more savings rates are beating the increase in the cost of living, savers are growing increasingly restless with their returns.

Danny Cox, head of financial planning at Hargreaves Lansdown, said the fund supermarket had seen an increase in the number of ISA savers transferring from cash to stocks and shares "to get additional yield because cash rates are so low".

He said stocks and shares ISAs were a particularly good for investors as the returns made on the investments – whether that is income produced by the investment or capital growth of the investment – roll up tax-free.

For those who want to beat savings rates but who are new to stocks and shares investing, Cox recommended "equity income funds". These funds typically invest in high-quality companies that pay reliable, and hopefully increasing, dividends to provide the income.

"Equity income investing could yield around 3.5% and is tax-free if you invest through an ISA, and you also hope you will get some capital growth," he said.

While cash ISAs may be good for accessing your money, Cox said those putting money into a stocks and shares ISA should be willing to lock it away for at least five years and possibly 10 years.

"Conventional wisdom is [you need to invest] for five years plus," he said. "You can make money more quickly but there are no guarantees and you are probably increasing the risk [you have to take]."

He added that investors need to "find the right fund manager" who has a good track record and make sure the money is diversified into a number of different investments so if one investment falls the impact on the savings pot is not too great.

Low rates to persist?

Although more savings rates beat inflation, which is good news, unfortunately there is unlikely to be any major increases soon.

This is part to the historically low interest rate, or base rate, set by the Bank of England, which has been at 0.5% for over five years.

Charlotte Nelson of comparison site Moneyfacts.co.uk said the Bank is taking a "cautious approach when considering the base rate with low inflation and uncertainty across the world".

"The Bank knows that having an interest rate at 0.5% for so long is unhealthy by they are struggling with the issue that raising interest rates will cause a slowdown in business lending in turn, slowing down an already sluggish GDP," she said.

Nelson and Cox both predicted that interest rates were unlikely to rise before 2016 and then when they do start to go up it slow, incremental increases.

However, it is not just a low base rate that savers are having to contend with, there are other factors that are keeping savings rates low.

The main one is the government's Funding for Lending Scheme (FLS). This was launched in the summer of 2012 and made £80 billion available to the banks and building societies to lend out as mortgage loans. Even though this the scheme came to an end for residential mortgages in January last year its effect is still being felt.

"Since the launch of FLS banks now no longer need to rely on savings to fund their mortgage lending," said Nelson. "Because of this, providers who are not normally providing the best buy rates have slowly risen to the top of the charts. This has resulted in products being withdrawn or vastly reduced due to oversubscription."

Further bad news for savers is that just because FLS has finished does not mean that rates will rise soon. Banks and building societies who took advantage of the facility have five years to lend the money out, meaning their coffers could be well stocked for another four years before they have to rely on savers' deposits to fund mortgages again.

"With base rate expected to continue to remain at a record low, it is only going to lengthen savers' pain," said Nelson.

"Even if there was a base rate rise [FLS means} there would be no guarantee that this would be reflected in a savings rate rise."

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