Hi °C | Lo °C Question: I have seen a number of adverts from the various banks and building societies which offer increased rates on deposits. Why is this?
Answer: Things have stabilised somewhat since the major sub prime fall-out hit markets around the world almost two months ago.
This was caused by a number of financial institutions going bankrupt as a result of defaults on payments, and the ripple effect went beyond the lending markets.
As with any properly diversified investment portfolio, one downturn in a particular asset class, in this case equities, leads to an improved performance in another, cash deposits.
With the major financial institutions still feeling the effects of the credit crunch, the banks and building societies have to look around for alternative ways to fund their lending business, such as mortgages and loans.
The most obvious way for the banks and building societies to raise this money now, is to look to their own existing customer base and try to attract new deposits from them.
More than 20 banks and building societies have improved their deposit rates over the last two weeks, which normally only occurs when there is a rise in overall interest rates set by the Bank of England.
Fixed rate savings which normally have some sort of lock-in period, are now offering their highest returns for more than six years.
Rates on savings bonds, again normally invested for a fixed period, have exceeded the seven per cent return barrier also.
The longer you can afford to tie up your deposits without access, the better the rate you can achieve from the many that are out there.
Many of us think, however, that this is as high as rates will go for the foreseeable future.
It is hard to see any further rises as the money markets appear to have peaked; however, there could be some small adjustments as the banks seek to secure the top spot of the "best buy" tables published in the press and various publications.
Anyone intending to lock into the current rates should seek to do so now, as the offers could start to be withdrawn as soon as the lenders have attracted sufficient duty, and once that happens the rates will start to fall again.
The current increase in rates could be of benefit to a number of individuals.
One group to whom it could provide a window of opportunity are those with mortgages that are fixed at rates less than the rate of interest earned from deposits.
Traditional advice that states individuals should seek to overpay their mortgage as often as possible may need a rethink.
Some borrowers have locked into rates as low as 4%, so instead of using any spare cash to reduce the borrowings, they could think about investing it at rates significantly higher than they are borrowing.
It could be a way of making a small amount of money for taking no risk.
The main consideration however is the impact of tax. For basic rate taxpayers, a gross return of 7% is reduced to 5.6% after tax, with higher rate taxpayers receiving only 4.2%.
So make sure you look at your individual tax position to ensure you maximise returns. For those looking at sheltering the tax altogether you should also take into account savings vehicles, such as pensions.
A number of providers are offering excellent rates at present. Again if assets can be tied up for longer periods, then investors can benefit from higher than normal rates.
Bonds with an element in cash can also shelter the tax position, particularly if you are a higher rate tax payer.
So as I commented earlier, act now if you want to take advantage of the upturn in the asset class of cash.
Raymond Mulligan is managing director of Johnston Campbell, a company of independent financial advisers regulated by the Financial Services Authority.
