As a new tax year starts, many savers will be motivated to make this the year that they take charge of their savings.
But with savings rates languishing at low levels for such a long time and even with the hope of a Bank of England base rate rise next month, there is a real concern that savers are becoming increasingly tempted by products offering high rates of return - without fully understanding that with the higher return comes higher risk.
For example, a number of clients have contacted us with questions about why products they perceive as savings ‘bonds’ are not in our best buy tables or wanting to understand how the new Innovative ISAs are offering rates almost double what the traditional cash ISA providers are offering. So, there is a real concern that many savers who don’t seek advice could be buying a wolf in sheep’s clothing.
In this article, we aim to explain the differences and highlight the risks, to enable you to make an informed decision about these products and judge if they are right for you.
Savers looking to boost their returns are becoming increasingly tempted by ‘bond’ products that are passing themselves off as, or look very similar to, deposit savings accounts, but are actually investments and can be far riskier than a cash account.
The trouble with the word ‘bond’ is that it’s applied to so many variations of both investment and savings products, so it can be hard to differentiate between them and that is why consulting a good, reputable adviser is key.
We’re not saying that there is anything wrong with these products per se, but we do believe in calling a spade a spade.
It’s important to ensure that you really do understand what you are putting your savings into, how it differs from cash and that you understand the risk implications, before you make any investment decisions - which is what these bonds are.
One series of products we are often asked about are the Castle Trust Fortress Bonds, which currently pay 3.00% AER on a one-year bond, up to 3.50% AER on a five-year bond.
If these were standard deposit accounts, then they would be topping our best buy tables, paying rates in excess of standard best buy fixed rate bonds .
But these bonds are loan notes – primarily to UK residential property owners, secured by a mortgage. Therefore, they hold a very different risk to deposits placed directly in a bank or building society savings account.
Different levels of protection
The Financial Services Compensation Scheme (FSCS) limit of £50,000 for investment products applies to these bonds if the company, Castle Trust in the example given previously, was to fail and if the claim is validated.
This is a very different scenario and offers far less than the protection you would have in a deposit savings account, which is a simple, guaranteed £85,000 per person, per banking licence. For more information read our FSCS Licence Guide
Innovative Finance ISA
Another investment that is regularly confused with a traditional deposit savings account, is Peer to Peer Lending (P2P) and even more so since the Government introduced the Innovative Finance ISA (IFISA) in April 2016. The IFISA allows individuals to use their annual ISA allowance to lend funds through P2P and enjoy tax-free interest and capital gains.
The rates offered by IFISA providers are typically around double the rates offered by many of the traditional bank or building society cash ISA providers - making them extremely attractive to savers looking to boost their return.
However, these two forms of ISA are inherently different and it is important to understand the key differences and the varying risks and complexities associated with products that are not simply deposit based.
The key premise behind P2P lending - the type of loans which are held in an Innovative Finance ISA - is that it cuts out the 'middleman’ bank, allowing borrowers to pay less in interest but also allowing investors to receive more.
But the loss of this ‘middleman’ is key, as it means that your money is not protected by the FSCS*. And there is no guarantee of the return, unlike on a standard savings account, such as a fixed rate bond or cash ISA. If too many borrowers default on their repayments or there is a delay in the funds being lent, the return may not be as much as expected.
That said, as long as savers understand what they are investing into, there is no reason why some would not be happy taking this risk in order to potentially gain the extra reward.
So to conclude, if the rate of return you can see is market-leading but not on our best buy tables (remembering that we research the WHOLE savings market on a daily basis) then the chances are that it is not a deposit-based savings account and therefore a higher element of risk will be involved.
If in doubt you can always give us a call 0800 011 9705 or send an email to [email protected] and we can help you understand more about the product in question. If it is an investment product, we will not be able to provide advice directly on the appropriateness of the product but we can introduce you to trusted experts who will be able to advise you on whether the particular product is right for you.
*No FSCS protection is available in the event of the P2P platform operator defaulting but is available if arranged through an adviser and the advice is considered unsuitable.