Exploring alternative options to traditional savings accounts is becoming increasingly important for individuals seeking to maximise their returns. While savings accounts offer security, they often fall short in terms of yield. Here are some other options.
Table of contents:
1. Individual savings accounts (ISAs)
2. Money market funds
3. Fixed-term deposits
4. Peer-to-peer lending
5. Government bonds
2. Money market funds
3. Fixed-term deposits
4. Peer-to-peer lending
5. Government bonds
1. Individual savings accounts (ISAs)
Individual savings accounts (ISAs) are a cornerstone of the UK's savings landscape. They provide tax-efficient options for both short-term and long-term financial goals. There are different types of ISAs, the most common being cash ISAs (both in the form of easy access or fixed term access) and stocks and shares ISAs.
Advantages of ISAs:
- Tax efficiency: ISAs allow you to earn interest tax-free, which can be a significant advantage. With a traditional savings account, you’re liable to pay income tax on any interest above your personal savings allowance: basic rate taxpayers can earn £1,000 before paying tax; higher rate taxpayers, £500; additional rate taxpayers, £0. (If your non-savings income is under £17,570, you may also get up to £5,000 of interest that you don't have to pay tax on, called a ‘starting rate for savings’.) But if you use an ISA, every tax year you can save up to £20,000 tax-free. You can put this all in one ISA account or split it across multiple accounts. All tax is subject to personal circumstances. Contact a professional if you require any tax related advice.
- Diversification: Stocks and shares ISAs enable you to diversify your portfolio, potentially leading to higher returns compared to standard savings accounts.
Disadvantages of ISAs:
- Risk exposure: While cash ISAs are relatively low risk, stocks and shares ISAs involve exposure to market fluctuations, which may result in losses. Many like to spread their allowance between both to mitigate risk.
- Annual contribution limits: ISAs have annual contribution limits, restricting the amount you can invest or save tax-free in a single year. The standard contribution limits are up to £20,000.
ISAs - the bottom line:
ISAs are a great way to earn tax-free interest on your savings. Be sure to check how frequently your ISA provider allows withdrawals before you invest as some are easy access but many are fixed. Also check for fees. Cash ISAs are typically a low risk option compared to stocks and shares ISAs.
2. Money market funds
Money Market Funds (MMFs) are a versatile option for those seeking a balance between liquidity and yield. Traditionally MMFs had a huge minimum buy-in (sometimes over £1m!) and were subject to high fees charged by asset managers, putting them out of reach of many ordinary investors. Thankfully this is rapidly changing, and MMFs are more widely accessible.
Advantages of money market funds:
- Liquidity: Money market funds offer daily liquidity, allowing investors to access their funds whenever they’re needed.
- Stability: Investments in short-term, high-quality debt instruments provide stability.
Disadvantages of money market funds:
- Lower returns: Returns are typically lower compared to riskier investment options.
- Market risks: While considered low risk, money market funds are not entirely immune to market fluctuations.
Money market funds – the bottom line:
Money market funds are a great alternative to savings accounts as they usually offer higher returns and are generally considered fairly low risk as they are diversified across many financial instruments. On Lightyear, you can get up to 5.37% AER with AAA-rated BlackRock money market funds through our high interest Vaults. As with any investment, returns are not guaranteed, and your capital is at risk. Rate is variable as of 12.07.24.
3. Fixed-term deposits
Fixed-term deposits offer a fixed interest rate over a predetermined period, providing a balance between security and yield.
Advantages of fixed-term deposits:
- Predictable returns: Fixed interest rates provide a predictable stream of income, making it easier to plan for the future.
- Higher interest rates: Fixed-term deposits often offer higher interest rates compared to standard savings accounts. Note that this isn’t always the case - especially when interest rates are predicted to drop in the near future.
Disadvantages of fixed-term deposits:
- Lack of liquidity: Funds are tied up for the duration of the fixed term, limiting access to your money in case of emergencies.
- Interest rate risk: If interest rates rise during your fixed term, you might miss out on potentially higher returns.
Fixed-term deposits – the bottom line:
The key difference between fixed term deposits and classic savings accounts is that the former have, as the name suggests, a higher but fixed interest rate on tied up savings, whereas the latter have a variable interest rate but with flexible access.
4. Peer-to-peer lending
Peer-to-peer (P2P) lending platforms connect borrowers with individual lenders, offering an alternative to traditional banking channels. It is important to note that P2P lending may seem like a savings method, but really is investing and does not have a savings safety guarantee. Borrowers are credit checked and rated according to risk.
Advantages of peer-to-peer lending:
- Higher returns: Peer-to-peer lending can provide higher returns compared to traditional savings accounts.
- Diversification: Investors can spread their risk by lending to multiple borrowers.
Disadvantages of peer-to-peer lending:
- Default risk: There is a risk that borrowers may default on their loans, leading to potential losses for lenders.
- Lack of regulation: Compared to traditional banks, P2P lending platforms may have fewer regulatory safeguards.
Peer-to-peer lending – the bottom line:
P2P lending offers higher returns than traditional savings accounts as these are investments made to borrowers, but as they are investments, they come with greater risk.
5. Government bonds
Bonds are another type of fixed-income instrument. They represent a loan by an investor to a borrower - in this case, a government. Buying bonds can be thought of as buying IOUs. Government bonds are considered a low-risk investment option, providing a secure avenue for capital preservation.
Advantages of government bonds:
- Safety: Government bonds are backed by the issuing government, making them a relatively secure investment.
- Stable returns: Regular interest payments and the return of the principal at maturity offer stable returns.
Disadvantages of government bonds:
- Lower returns: Government bonds generally offer lower returns compared to riskier investment options.
- Interest rate sensitivity: Bond prices may fluctuate based on interest rate movements.
Government bonds – the bottom line:
Bonds are also a form of investment, meaning that, although they are relatively safe and offer higher returns than savings accounts, your money is not protected by a savings safety guarantee.
Diversifying your savings strategy beyond traditional savings accounts can be a prudent financial move, but it's crucial to carefully weigh the advantages and disadvantages of each option. Whether you prioritise tax efficiency with ISAs, the balance of money market funds, or the predictability of fixed-term instruments, understanding the nuances of each alternative will empower you to make informed financial decisions aligned with your goals and risk tolerance. Consulting with a financial advisor can provide personalised insights, ensuring a strategy tailored to your unique financial journey.
Disclaimer
This article is written for educational purposes only and should in no way be taken as investment advice. When investing, your capital is at risk. Seek guidance if necessary.
Paula is a Communications Specialist at Lightyear, sharing news about the platform across the media and investor communities with a focus on Hungary, Spain, Portugal and Germany. She’s worked in marketing and communications across a variety of sectors over four years, and ran her own marketing agency for the better part of two years.
