Beyond the point of low return

If you have divided up your savings and put the minimum qualifying amount into accounts with all the top 20 building societies, you are probably happy to put up with derisory rates of return of 2-4 per cent while you wait for your windfall. But interest rates on small sums in most banks and building societies accounts have shrunk to levels which, especially after tax, are unacceptably low.

If, like most people, you are looking out for a better rate of return without running any real risk, you will have heard of guaranteed income bonds, offered by a dozen or so insurance companies. They guarantee to pay your capital back in full, plus a fixed rate of return over the life of the bond, which is usually not less than five years. Premium Life (0800- 414111) currently offers the widest range of rates, from 3.9 per cent on pounds 1,000 for a year up to 5 per cent for three years and 5.6 per cent for five years. On pounds 10,000 the rates range from 4.9 per cent for a year to 6.5 per cent for five years. Guaranteed growth bonds are similar but pay out a lump sum on maturity, currently anything from 30 per cent over five years on small sums to 35 per cent on pounds 10,000, instead of a regular income.

The returns are better than a bank or building society would offer. But the return is firmly fixed, and there are penalties to pay if you want your money back early. If you are concerned that either for political or economic reasons the next move in interest rates will be up, then you will not want to lock your money up for more than two years at the most, and if you also think the rate of inflation is likely to rise then you should not be looking at a GIB.

A better bet for the risk-averse investor might be a guaranteed equity bond, which pays no income but guarantees the return of capital plus a variable return based not on interest rates but on rises in the FT-SE 100 share index during the life of the bond. Most GEBs only pay out part of the gain, however.

Rather more adventurous is the 24th issue of the TSB's guaranteed stock market bond, which guarantees the investor the full return of all money invested, plus any gain in the FT-SE 100 share index in full, with the finishing level averaged over the final year to spread the risk, and any increase in excess of 25 per cent during the life of the bond guaranteed in full even if the index subsequently falls back below that level. Gains are normally paid tax-free to basic-rate taxpayers.

The downside is a 5 per cent initial charge, which reduces the base for both the guarantee and the gains to 95 per cent of the sum invested. The minimum investment is pounds 2,000 (call 0345-123900 24 hours a day)

Better still might be a guaranteed unit trust, which is set to become the next new mainstream investment for private investors and pension funds, according to Richard Bolchover, deputy managing director of Close Fund Management, part of the Close Brothers merchant bank. These are unit trusts, which can be bought and sold daily, but by using derivatives managers can protect against falls and lock in any gains at the end of each quarter.

Guaranteed unit trusts could appeal to risk-averse investors, especially those approaching retirement, but they are equally intended to appeal to the pounds 600bn pensions industry including providers of personal pensions, group personal pension plans, self-invested pension plans, group money purchase and defined benefit pension schemes and additional voluntary contributions by protecting money-purchase pensions from a slump in stock market values just as individuals reach retirement.

The Close UK Escalator 100 offers complete protection against a falling market, the slightly riskier Escalator 95 the maximum loss in any one quarter is 5 per cent, and for this the index has to fall 15 per cent. Derivatives allow investors to share the risk premium and benefit from accrued dividends.

There is an up-front charge of 5 per cent before the balance is invested. No dividends are paid out but all profits are treated as capital gains. Minimum investments are pounds 1,000 or pounds 100 a month.(call 01277-690455 or contact an independent financial adviser).