Fixed-rate bonds: is it worth locking your money away?

Banks are hoping to tempt savers to commit to longer-term investments through improvements to their fixed-rate bonds. But is it enough?

Tesco Bank is one institution that has recently refreshed its fixed-rate bond range. An increase to its 3-year bond this week (up to 2.30%) is accompanied by new 1-year, 4-year and 5-year deals.

The 1-year bond, at 1.75%, remains some distance short of the best performers for this term, with Britannia (2.03%), the Post Office (1.99%) and Aldermore (1.85%) all offering more.

But the longer-term 4-year and 5-year deals have more impact, and enter as the most competitive rates for those terms in the market, at 2.65% and 2.95% respectively.

In the mid-term market, Aldermore has launched a new 3-year bond at 2.40%, which sits in the top five for its term, below ICICI (2.55%) and Vanquis (2.41%).

How the new offerings compare to the market leaders.

Tesco Bank offers market-leading bonds for long terms. But do they warrant locking funds away for up to five years?

Worth Locking Away Your Savings? Editor's Comment

It’s a constant nagging dilemma: how to squeeze every last drop out of your savings, as rates remain low and inflation remains stubbornly high. The fact remains that, after tax, even the returns from five-year bonds will struggle to keep pace with inflation if it remains comfortably above 2.5%.

So what are the alternatives? The top easy-access accounts are only offering 1.40% after tax – half the current rate of inflation – and many will question whether the extra few tenths on offer merit locking away access to their funds for a couple of years.

One obvious alternative is a tax-free ISA, at least 10 of which (easy access or short-notice) are currently offering 2.00% or above.

A fixed-rate bond would have to offer at least 2.50% to match this return after tax – and that means locking funds away for at least four years.

(For more on cash ISAs vs. fixed-rate bonds, see our savings guide here.)

If you want the extra security of a guaranteed rate, the two-year fixed-rate ISAs from Britannia and Halifax will return 2.25% and 2.10% respectively, and no tax will be deducted. As an added bonus, both of these also allow new customers to transfer in their existing ISAs. (Find out how to transfer your ISA here.)

If you’ve got a large volume of savings, you can’t really look much further than the First Direct cash ISA, which offers 3.00% tax-free on balances above £40,000.

The cash ISA from First Direct beats inflation - if you have £40,000 to transfer in.

The other alternative, as we reported yesterday, is current accounts.

Both Santander and Nationwide are offering interest-paying current accounts that surpass almost everything in the traditional savings account market.

Both Santander’s 123 current account and Nationwide’s FlexPlus account offer up to 3% interest, while Nationwide’s FlexDirect offers up to 5% for the first year on balances up to £2,500.

There’s the added convenience of not having to manage multiple accounts. And while switching bank accounts has always been seen as the biggest hindrance in personal finance, that should change altogether next month when a new seven-day switching system is launched (read more).

Bonds remain a solid (if not spectacular) option once an ISA allocation is used up, and they guarantee a fixed return while savings rates continue to disappoint.

But if you’re prepared to become more receptive to the idea of switching bank accounts more frequently, this could also benefit your savings for the foreseeable future.

James Booker and Keith McDonald

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