Beat the savings squeeze despite falling interest rates and higher tax

Ireland's 380,000 Vodafone shareholders were rewarded this month when the company began paying them cash following the sale of its US business Verizon. A typical Vodafone shareholder with 1,000 shares, (who sells their allocation of Verizon shares) stands to receive a cash payout of about €1,250.

For those able to resist going on a shopping spree, the next question is: what should you do with the money? It’s a question not so easily answered. The average deposit account pays just 2.13 per cent interest, according to the Central Bank, with interest rates falling for 21 consecutive months. Savers have also been hit by increases in Deposit Interest Retention Tax (Dirt) which stands at 41 per cent, while deposit interest is now liable for PRSI of 4 per cent.

"Rates have been reducing, Dirt has been increasing and so for consumers, to even make their money stay still, it's gotten harder and harder," said David Kerr of price comparison site bonkers.ie.

So what can you do to make your money work harder?

Choose the best deposit account
The majority of clients that Aoibheann Daly, portfolio consultant with Irishdeposits.ie, sees still aren't ready to move into anything other than deposits. "For those people, it's more important than ever to shop around," she said.

Daly says that demand accounts, where there is instant access to cash, have been very popular over the last number of years. The downside for consumers is that the interest rate on these accounts is variable so can change at any time.

The best demand account is KBC’s Smart Access Demand Account, which currently pays 2.3 per cent on amounts up to €100,000 on minimum deposits of €3,000. However this rate will drop to 2 per cent in May.

If you want to be sure of how much interest you are going to earn, you should look at a term account where you lock your money away. PTSB pays 2.4 per cent AER on its 16-month term account on balances above €5,000.

For most savers, though, the returns will disappoint. For example, €10,000 deposited in PTSB’s 16-month account earns just €177 net interest after Dirt and PRSI is deducted.

What about An Post?
Up until last year, State Savings products, which are sold by An Post, paid a better return than what could be got from the banks. However, rates paid on State Savings products have been slashed three times over the past 18 months.

Deposit experts say that it’s really only the longer-term State Savings products that are now worth considering. Of these, the four-year National Solidarity Bond pays 1.47 per cent AER, while the 10-year bond pays 2.66 per cent AER.

Returns on State Savings products are Dirt free, so the interest you will ultimately receive is slightly more attractive than what you will get from a bank. The question for Kerr is, “are you willing to lock your savings away such long periods?”

Are tracker bonds the answer?
Fixed-term investments like tracker bonds, where the majority of your money is invested in a deposit-based account while the remainder is invested in a stock market index, are seen by many as the natural alternative to deposit accounts.

Your capital is typically 100 per cent guaranteed while also allowing you to participate in gains in the stock market. The lure of sharing in the upside in the stock market with none of the downside is a sales pitch that many consumers find hard to resist.

So do capital guaranteed investments beat deposits? Research suggests not. Boutique investment consulting firm iCubed compared the overall returns of 62 capital guaranteed products maturing in 2012.

According to iCubed, 28 of the 62 delivered 0 per cent growth while the average annual return was an unimpressive 0.85 per cent. "These products are a great triumph of style over substance," says Gary Connolly, founder of iCubed, adding that "some of them are absolutely shocking".

That said, while the majority of the products in iCubed’s study performed poorly, there were exceptions. The best-performing product returned an average of 12.05 per cent of year while the next best returned an average of 5.39 per cent a year.

Gary Hanrahan of Capital Options, an adviser, likes the Triple Option Account Series 4 from KBC which is available over a three, four- or five-year term. The account is 100 per cent capital guaranteed and gives investors the opportunity to participate in the performance of the Swiss Market Index.

Interest paid on the account will be twice the performance of the index up to a maximum of 10 per cent in the three-year option, 16.5 per cent in the four-year option and 25 per cent in the five-year option. “So if the Swiss market is up 10 per cent over after three years period you get twice that, which is a 20 per cent return,” Hanrahan says.

The account closes to new investors on March 28th and the minimum investment amount is €25,000. Interest payable on the account is subject to 41 per cent Dirt.

Time for some risk?
According to David Quinn, of fee-based adviser Investwise, people understand that they need to invest in real assets to beat returns on deposits but are afraid of suffering the kind of losses that happened in 2008.

“Deep down, consumers know they have to take on risk but it scares them, and unfortunately they don’t know where or what to invest in,” he says, adding that capital-guaranteed products feed into people’s fears very well.

Quinn says that understanding what level of return you need is the first step in determining what level of risk you should take on and what you should invest in.

“An older person with a defined benefit pension may only need to beat inflation so can stick with deposits. A 35-year-old pension investor, on the other hand, is going to probably need a return of maybe 8 per cent and consequently take on more risk.”

In order to get close to an 8 per cent annual return, you are probably going to have to invest in the stock market, with investment in a broad index of shares being less risky than buying the shares of individual companies.

One example of a share index is the MSCI World Index which is made up of more than 1,600 companies spread across 23 developed markets. Over the past 10 years it has risen by an average 7.3 per cent a year. “But to get this kind of return, you need to be able to ride out the huge swings,” Quinn says, suggesting that to get exposure to a stock market index, you should opt for a low-cost exchange-traded fund or index tracker.

Absolute return funds, which aim to generate a return in both rising and falling markets, may also interest investors looking to beat deposits but willing to risk their capital.

“I’m a fan of Standard Life’s Global Absolute Return Strategies Fund,” Hanrahan says, adding that “it does what it says on tin.” The fund has returned an average of 8.6 per cent a year over the past five years.

For those considering taking on more risk though, he adds, “it’s vital to get independent advice before jumping into any particular product” adding that “there is also a risk in doing nothing.”