Jenny Lowe surveys the options for investors who don’t want to give up the security of cash, even with interest rates at historic lows.

In turbulent times for investment markets, investors will be keen to head for the relative security of cash. But with interest rates plunging to historic lows and banks no longer seen as wholly secure, where can they go for security and a reasonable
return?

Last year saw markets around the world shaken to their foundations, sparking an unprecedented flight to safety. According to Virgin Money’s Investor Intentions index,
short-term confidence in equity investments has been severely shaken by recent market
events and the warnings of more gloomy economic news to come.

‘The shift to cash and bonds is a sign of the times, with stock market volatility high and
almost daily doses of bad news hitting investors should keep an eye on their longterm
goals and seek professional advice before making any decisions.’

Over the long term, holding a high proportion of your portfolio in cash can be risky and, since the Bank of England’s Monetary Policy Committee began slashing rates in order to
stave off a deep recession, bank and building society accounts have suffered greatly.

That said, most advisers encourage investors to hold a least some of their portfolio in
readily available funds. Danny Cox, head of financial advice at Hargreaves Lansdown, suggests that ‘Everyone needs some form of cash position to provide an emergency fund or cash cushion, and typically this will be equal to six to 12 months of your expenditure. This cash position will obviously increase as you get closer to retirement, and at that point you could have as much as 40 per cent in cash or low-risk bonds.’

Who’s looking after your cash?
A high-interest savings account is the usual first stop for an investor with cash to spare. confidence in shares,’ explains Scott Mowbray, spokesman at Virgin Money. ‘It is clearly a case of safety first.’

Limited incentives
Investors can certainly be forgiven for thinking that the best place for their capital is under the mattress or floorboards. The latest Investor Outlook report from Lloyds TSB Wealth Management revealed that over a quarter of stock market investors have opted to move some, or all, of their money into more cautious investments, such as cash or bonds.

Nathan Moss, managing director at Lloyds TSB Wealth management, explains, ‘Money is still moving to “safer” investments, such as cash or bonds, as confidence in the future of the markets continues to be shaky.However,

‘Over a quarter of stock market investors have opted to move some, or all, of their money into more caution investments, such as cash or bonds’

However, since the crunch began to bite, banks and building societies have withdrawn almost a quarter of all savings accounts and slashed average interest rates. In the past 12 months, the number of instant-access accounts has decreased by over 23 per cent, from 1,478 to 1,136, and of the 507 savings accounts that were paying 4.5 per cent AER in January 2008, only 11 remain, paying greatly reduced rates.

The past few years have also seen a rise in the number of internet-only savings accounts offering higher rates of return. However, as recent months have indicated, you have to be careful that the institution you choose is covered by the Financial Services Compensation Scheme (FSCS) – up to a total of £50,000.

For example, with internet accounts in particular, you often find groups based overseas featured in the best-buy tables. Icesave was one consistently featured as having a high headline rate for its online savings account. However, as most will recall, the bank collapsed as the credit crunch took hold and many UK savers were left wondering if they would get their money back.

However, it is important that investors know what is on offer and do their research in order to find the best product for them, advises Cox.

‘People need to make sure they shop around, and at the same time you need to be mindful that those institutions that are paying the high rates are probably the ones that need to get the money the most, so there is a risk and reward scenario. This makes it even more important for investors not to commit more than £50,000 to any one institution.’

He adds, ‘ICICI, for example, is paying 4.65 per cent at the moment, and while they
are an Indian bank, they come under the FSCS protection. The main question you should ask yourself is how comfortable do you feel putting your money with a foreign group, as opposed to a high street bank such as HSBC, which is probably a much more
stable organisation.’

Under lock and key
Of course, if you are willing to give up instant access, the rates that are available will be
somewhat higher. For example, FirstSave’s 90- day notice account offers a rate of 4.5 per cent gross/AER and its 30-day account offers a rate of four per cent gross/AER.

You should, however, consider the longer term, as banks and building societies often use an attractive rate to lure you in, only to switch it to a much lower one at a later date, leaving you much worse off than if you had opted for an account that has a lower starting, but more consistent, rate. Sharon Bratley of Fairinvestment.co.uk explains,

‘There are still some great savings account deals to be had. The Halifax International Regular Saver offers a great rate of six per cent, while instant-access accounts are still offering rates above the Bank of England’s 1.5 per cent, like the Alliance & Leicester eSaver at 3.6 per cent AER and the Abbey Instant Access account, which offers a return of 3.5 per cent AER.’

Help from the taxman
According to recent figures from the independent comparison website, cash ISAs
are a close second to savings accounts when it comes to choosing where to keep cash. Bratley adds, ‘Cash ISAs offer great value for money because you can invest up to £3,600 each year tax free. Considering that the average amount saved is less than £3,000, cash ISAs make sense, especially because most offer instant access and high interest rates compared with standard savings accounts.’

Alternatively, there is the option of National Savings Index-Linked Certificates, which
provide a hedge against inflation by offering a guaranteed rate of interest above the Retail Prices Index over two or five years. Danny Cox explains, ‘National Savings Index-Linked certificates are a good mediumterm investment, and at the moment, with inflation decreasing, they are offering investors a return of one per cent above the rate of inflation. The good thing about them is that you are guaranteed a tax-free return above the rate of inflation, but the bad news is that inflation, at the moment, is declining and so the rate of return is declining too.’

He adds, ‘If you want to guarantee your capital, don’t want to take any risk with your money and want to beat inflation, then they are a reasonably good home for your cash at the moment, but they will get worse before they get better.’

Fixing your return
Depending on your view of the market in the near future, another option for savers would be to get a savings deal that comes with a fixed rate. Fixed-rate bonds pay a set amount of interest for a certain period of time and then at the end of the term you get your capital back, plus the interest. The length of the term can be anything from six months to five years, but in general, the longer the term, the higher the interest rate.

If you opt for a fixed-rate product, however, it is important that you take into account the wider interest rate picture. If interest rates are falling then fixing can be a great idea, but there is a risk – you could find yourself stuck with an uncompetitive product if rates start to rise during your fixed term.

Since the onslaught of the credit crunch, one- and two-year fixed-rate deals have become very popular among investors, simply because if rates do start to improve, you aren’t tied in for too long. ICICI bank’s Hi Save Fixed Rate, which has a 12-month term and requires a deposit of £1,000, is currently offering a rate of 4.65 per cent and Anglo Irish Bank’s 1-year bond is offering 4.6 per cent.

A temporary holding
Of course, you may only be holding cash in savings accounts for emergency funds to which you would need immediate access or for the very short term prior to investing in something else. But, if you are holding cash pending stock market investment, there are some other options available. First and foremost are money market funds. These offer similar security and rates of return to cash deposits and also allow savers to protect themselves against the risk of a single bank collapse or default by spreading their
money across a range of financial institutions.

A Fidelity International spokesperson says, ‘Savers who opt for a money market fund have effectively hired an expert investor to constantly seek out the best interest rates in the market on their behalf. And what you see is what you get – there are no introductory rates and no lock-ins.

‘Money market funds should also appeal tothose savers who have been unsettled by the
credit crunch. These funds spread a saver’s money across highly liquid cash-like securities issued by a wide range of financial institutions and top companies and so provide some protection from the collapse or closure of a single financial house.’

A typical money market fund has an investment horizon of two to three years, but
investors in these vehicles usually have the option to access their cash instantly if they wish. The assets within a money market fund are pooled together and the money is actively managed by a fund manager who has several responsibilities, including looking across the world’s financial markets for the best interest rates offered, deciding when the central banks in different regions will change interest rates and evaluating any credit risk.

Growing popularity
These vehicles are very popular in Europe, but are yet to really take off in the UK. However, according to Barclays Wealth, this trend has been changing since the credit crunch took hold. Its research revealed that the Money Market sector was increasingly popular among those investors seeking increased security and growth potential, as Chris Stevenson, associate director, funds market, Barclays Stockbrokers, points out: ‘Market volatility has continued to dominate the headlines so a cautious approach from investors comes as no surprise.We saw Money Market funds dominate assets invested over the second quarter of 2008, confirming investor need for protecting investments.’

Protected funds are an alternative to money market funds, and investors can sit safe in the knowledge that, whatever happens to markets, their investment will not fall, or will fall by only a limited amount, allowing for a real sense of security and safety. These vehicles are well suited for all kinds of market conditions, whether markets generally are moving up, sideways or down. In all cases, protected funds will offer you the security of capital, plus the opportunity to capture any upside gains. Close Investments, for example, runs a 100 per cent protected fund known as the Close Escalator 100 Fund which is akin to a cash fund. This product has 100 per cent quarterly protection so most of the money from investors is invested into very secure cash-like instruments and the remainder is used to gain upside exposure. At the end of the quarter, the secure cash-like investments will have at least retained their initial value, which provides the capital protection, and, of course, investors also benefit from any increase in value from the upside exposure.