How to make the most of £100,000

SAVERS have been hit hard by low interest rates, which have largely wiped out bank and building society returns since the base rate hit 0.5 per cent in March 2009. They have proved particularly punitive for those who rely on the income from their savings to live, such as the retired, widows or orphans.

Given that as recently as April 2008, base rates stood at 5 per cent, canny savers who shopped around for a decent margin above this, have seen their income more than halve.

Add into the equation, inflation at 3.7 per cent according to the consumer prices index, which excludes housing costs, or the 5.3 per cent of the retail prices index, which has a broader remit and it is clear savers are struggling to even maintain the value of their nest eggs.

According to Moneyfacts, the current average return on a savings account is a heart-wrenching minus 4.72 per cent after allowing for CPI inflation. The picture is worse when measured against RPI.

To stop your savings pot eroding, a basic rate taxpayer needs to find an account paying 4.63 per cent, while a higher rate tax payer has to earn 6.17 per cent, which is difficult to do.

Unsurprisingly, week in week out we receive letters to our Money Help Desk, asking where savers can find a better return. Unfortunately there are no easy answers. Such a letter came in by e-mail a few days ago from a reader in Biggar.

"Can you advise the best place to invest 100,000 to obtain a monthly income and yet preserve the capital sum intact. Most banks and National Savings appear to offer a very poor rate of interest. I would be grateful for your advice," wrote "ST".

We decided to ask the experts for their strategies and are publishing a range of views below. We have also outlined a ten-point plan offering some basic guidance designed to help savers know where to begin.

1 Make sure you hold on to every penny you earn by sheltering your savings in a tax-free wrapper, such as an Isa or by making sure any spouse's unused tax allowance is fully exploited, so that at least your interest can be enjoyed tax free.

2 You must proactively shop around regularly to make sure you are getting the very best return available. You can do this via our best buy tables published each week, or on the internet, via websites such as www.moneyfacts.co.uk.

3 Only hold a maximum 50,000 per person with any one institution so that your cash will be safe should the bank default.

4 Think creatively with an eye to the future. Be prepared to spread cash between different kinds of accounts to maximise returns. For example, a fixed account may pay higher interest right now. But if rates increase in the future, which they will do, there may be even better options to come. So, you don't want to lock all your money away now. Consider investing some in a fixed account now for more income, but keep some back for later opportunities.

5 Don't forget National Savings and Investments, not least their tax-free index-linked certificates, which will protect against inflation. The certificates are currently paying 1 per cent above the retail prices index of 5.3 per cent.

6 Consider a fee-paying current account with your bank. Some of the so-called "packaged accounts" which charge a monthly fee, pay a superior interest on savings. These accounts are expensive so should only be embarked upon if you are likely to use the range of services which they provide, so you get your money back. For example, some will offer free travel or breakdown insurance.

7 Look at regular savings as these can offer attractive rates for limited monthly injections. Northern Rock's regular saver is currently paying 5 per cent, but must be operated through branches. It has offices in Aberdeen, Dundee, Edinburgh and Glasgow.

HSBC's Preferential Saver is the only product that beats inflation for higher rate taxpayers, paying 8 per cent, but savers open a fee paying account with the bank to qualify. Thereafter the amount that can be invested is restricted to 250 per month (3,000 over the one-year term).

8 Exploit the kids. Some children's accounts have good interest, and youngsters can earn interest tax-free. If the money would be spent on holidays, treating and other support for grandchildren, or other family members, then make use of their personal allowances. The Halifax's Children's regular saver pays 6 per cent fixed for a year.

9 After that, consider taking a longer-term risk to put money in some form of collective investment, such as income funds, in the hope of a steadily rising income. But with markets volatile, this is only possible if you have cash you can afford to lose, you keep a big enough sum liquid to cover your immediate and foreseeable needs for the next few years, and you can sleep at night.

10 Some hybrid investments offer the prospect of a higher return via equity exposure while guaranteeing your capital sum if you sign up for five years. However, you need to read the small print carefully. The guarantee will not only come at a price, but be provided by a third party. These guarantees are not always as safe as promised.

WHAT THE EXPERTS SAID

Michelle Slade of Moneyfacts

Just a third of accounts on the market offer a monthly interest option. The highest rate on offer is 4.89 per cent from ICICI Bank UK and Coventry BS, but this requires you to commit your money for five years… something most savers are not looking to do in the current environment. For a two-year commitment, State Bank of India is paying 3.928 per cent, while Bank of Scotland is paying 3.54 per cent. Alternatively, Dunfermline Building Society is paying 2.47 per cent for a commitment of just over one year.

If you wish to maintain more access to your money then the Websave Bonus account from West Bromwich BS is paying 2.96 per cent, including a 1 per cent bonus for 12 months, and the ING Direct UK Savings Account is paying 2.72 per cent, including a 2.22 per cent bonus for 12 months.

All of the above mentioned accounts will accept an investment of 100,000. However, only 50,000 per person per deposit-taking provider is covered under the Financial Services Compensation Scheme (FSCS). If you invest the full 100,000 with a bank and the bank failed, you would only be eligible to reclaim 50,000 from the FSCS. If you want to maintain 100 per cent protection you would be better off splitting your investment amongst at least two providers.

Steve Wilson of Alan Steel Asset Management

As usual there is no magical solution in the current environment to creating income and guaranteeing the capital. Investors should be very wary of any guaranteed products out there and third party risks involved.

If, however, the client can take a bit of risk and a five-year view then equity income funds and even some cautious funds look great value. These provide investors with a good dividend yield with the aim of preserving capital, and ones to consider are Newton Higher Income yielding around 7 per cent, Psigma Income yielding around 4.5 per cent, which is managed by the highly successful Bill Mott who managed Credit Suisse Income for many years.

Much of the growth will come from overseas in future, and James Harries at Newton Global Higher Income is another excellent fund manager yielding around 4.8 per cent, achieving capital growth on top.

For those more cautious investors, Invesco Perpetual Distribution has a mix of equities and fixed-interest investments combining the expertise of Neil Woodford on the equity side and Paul Causer on the fixed-interest part. Together they provide a more cautious approach and yield around 6.7 per cent.

In the current low interest rate environment, investors have to seek alternatives to cash and we suspect this will remain the case for some time.

Danny Cox of Hargreaves Lansdown

If you do not want to put your capital at risk, you have few options. Interest rates remain very low and the best monthly income cash deposits pay less than 3 per cent in interest before tax. Shop around, however, and you might be able to improve your rate. The Buckinghamshire Building Society is paying 2.86 per cent and the West Bromwich 2.6 per cent.

If you are a non-taxpayer you can elect to have the income paid without any tax deducted. If you are a taxpayer, use your cash ISA allowance of 5,100 per tax year as this shelters your savings from cash. Northern Rock is paying 3 per cent on its cash ISA.

The problem with spending the interest on your cash is that over time, the buying power of your capital will fall due to rising prices. Beyond this the only way to increase the income is to take some investment risk with your capital.

Bryan Johnston of Brewin Dolphin

Obviously further investigation of the reader's risk profile would be essential before making specific recommendations but he talks about "preserving the capital sum intact". These markets cannot be guaranteed and not a penny should be committed to quoted securities which you might want to encash within the next three years. Although the correspondent talks about the need for a monthly income no specific figure is mentioned so I assume, that he is relatively risk averse.

There are a number of managed bond funds which pay their income monthly. These are professionally run portfolios investing in quoted debt paper, so of course there is a market risk, both in relation to the individual underlying company and to the trend in borrowing costs generally.

Still, in the contemporary climate I would prefer to go down this route rather than considering investing specifically in, for example, government issues. If a rather higher degree of risk was acceptable, an agreed proportion of the sum in question could be applied to some of the top-quality blue chip stocks, which are now standing on quite attractive yields such as Glaxo, Vodafone and the like.

Your correspondent could even consider BP, which now offers a prospective yield of 8 per cent. Given the company's current problems this would suggest that the market believes there is a risk of a cut in the payment, but even if this did happen BP would probably still pay a return of between 4 per cent to 5 per cent; moreover, one would have to take a very pessimistic view of the final consequences of the tragedy in the Gulf of Mexico before regarding BP as facing a terminal threat. Nevertheless, the risk associated with any investment in equities must be recognised. There are those suggesting that the key market benchmarks could fall back to the levels of last March and, if markets really did fall by 40 per cent from current levels, there would be very few safe havens.

Patrick Connelly, of AWD Chase de Vere

You are correct – most secure investments do offer poor rates of interest, but this is the only way you can achieve a return and be certain of keeping your capital intact. You may therefore need to make a compromise between the level of income you want, whether you are prepared to put your capital at risk and how much risk you are willing to take.

A cash ISA can provide you with a tax-free income of between 2 per cent and 2.5 per cent per annum, although you are only able to invest 5,100 each year. Other bank and building society accounts can pay interest of between 2.5 per cent and 3 per cent per annum, though these are gross figures and so taxpayers will need to pay tax on the interest. A gross interest rate of 3 per cent per annum equates to 2.4 per cent for a basic rate taxpayer and 1.8 per cent for a higher rate taxpayer.

It should also be recognised that if you take the income generated by a deposit account then your underlying capital will not grow and so the real value of your investment will be eroded by inflation over time.

If you are prepared to take a risk with your money in order to secure a higher income then you could consider investments such as Equity Income share funds or Corporate Bond funds, many of these are currently producing a yield of between 4 per cent and 5 per cent per annum.

However, we would suggest including other investments such as overseas shares and commercial property, which may bring down the overall yield on your investments but provide more diversification to give a greater chance of protecting your capital. The mix of investments should be determined by how much income you need and how much risk you are prepared to take. You should be aware though that any non-cash investments can fall in value and so you must be willing to accept this if you need a higher income.