A flutter on high odds is the only way to earn big returns

SAVERS desperate for more income than they are getting from their deposit accounts are taking on more risk in search of reward after the Bank of England kept interest rates at a record low for the 11th successive month.

Millions of savers have seen cash returns hit rock bottom since interest rates were cut to just 0.5 per cent last year, with the average instant access account now paying just 0.76 per cent. And with interest rates unlikely to rise significantly for some time, savers are taking on extra risk as they search for a more generous alternative to cash deposit accounts.

The quest for better returns propelled unit trust and individual savings account (Isa) sales to record highs last year as a growing number of savers turned to equities and corporate bonds, the Investment Management Association (IMA) revealed this week.

Tom Munro, director of Tom Munro Financial Solutions, said: "Cash is usually the first choice for generating income, especially for low-risk investors, but the financial crisis has shaken confidence in this, the most secure asset class of all, with memories of supposedly safe institutions on the brink of collapse still fresh, closely followed by plunging interest rates."

The alternatives are invariably less secure than cash, although the level of risk varies. Government bonds ("gilts") and investment grade corporate bonds are at the lower end of the risk scale, but even they are far from secure, with some commentators warning of a potential gilts bubble as investors rush in unaware of the potential risks.

Munro said: "Bonds, both government and corporate, offer a creditable alternative income generator to cash but there are risks, especially on corporate bonds, largely related to the solvency of the issuer."

Investors piled into corporate bonds in the first half of last year in particular as it became the best-selling fund sector of 2009, according to the IMA. Corporate bond yields are expected to be healthy this year, if less impressive than they have been, believes John Robertson, investment director at Williams de Broe in Edinburgh. He recommended accessing the asset through funds including the L&G Dynamic Bond Trust, and the M&G Optimal Income Fund.

"These are particularly attractive for anyone concerned about rising bond yields as they can shorten duration relatively easily," said Robertson.

However, Barry O'Neill, chartered financial planner at Thomson Shepherd, cautioned against relying solely on gilts and corporate bonds to provide their income, as they are generally fixed income streams. He recommended taking advantage of the dividends paid by listed companies to compensate investors for the capital they have injected.

"Fortunately, this now applies the world over, not just in the UK, so investors with an appropriate risk budget seeking income can now gain access to the long-term growth potential of overseas equity markets whilst in the meantime being compensated by a healthy stream of dividends," said O'Neill.

Dividends can be accessed through direct shares or collective equity funds, and the search for income has created renewed demand for equity income funds. There are about 80 equity income funds that invest primarily in UK shares and seek to produce a yield at least 10 per cent above that from the FTSE All-Share. The sector contains some of the UK's best-known fund managers, including Invesco Perpetual's Neil Woodford, but most were hit badly by the stock market downturn. Yet their focus on regular dividends ensures they remain popular with income investors.

Robertson at Williams de Broe favours funds including the Artemis Income, the Jupiter Income trust and the AXA Framlington Equity Income. Equity income funds investing internationally are increasingly commonplace, with Edinburgh-based Baillie Gifford among those preparing to launch a global income vehicle.

Individual shares are at the high end of the risk scale and suitable only for investors with large and well-diversified portfolios. For those investors, however, there are some attractive yields available at present, including GlaxoSmithkline (4.9 per cent), BP (6.6 per cent) and Vodafone (5.8 per cent).

Commercial property is another option and attracted some 1.4m of private money last year as the sector showed signs of recovering. But while the yields from commercial property funds can be attractive for those wanting income, they can also be volatile.

Munro advised investors taking extra risk in search of returns to spread that risk by diversifying across different asset classes.

"A well-diversified portfolio containing all four asset classes of cash, bonds, shares and property should meet most investors' income requirements over the longer term," he said.