Investing for Income: Make the best of a bad job

CAUTIOUS investors looking for monthly income from their deposits are going to be in for a lean time. With interest rates falling rapidly and expected to remain low for several years, the returns from building society savings accounts and Tessas will dwindle.

Investors who prefer a nice steady deposit account to taking a gamble on the stock market will be particularly hard hit. While their capital may be safe, their income is not. But since even risk-taking investors should keep a proportion of their funds in safe deposits, tumbling rates will hurt everybody.

Philippa Gee, the managing director of fee-based IFAs Gee & Company, says it is worth considering switching from variable to fixed-rate deposits to offset the impact of anticipated rate cuts, particularly when taking out a Tessa. She says a number of savings institutions have yet to reduce their interest rates following the latest 0.25 per cent base rate cut by the Bank of England. "If you are looking to lock in, do so now before rates fall further."

The problem with fixed interest accounts is that you have to tie your money up for the length of the term, with hefty penalties for withdrawals before the end, so only commit money you know you will not need.

With rates dropping rapidly, Ms Gee says investors should check the best-buy tables in the weekend press when deciding where to put their money.

"However, you should read these tables with caution. It is often better to go with a consistent performer than this week's number one." Ms Gee also urges investors to make the most of tax-free investments such as Tessas where possible to enhance the rate of return.

You are unlikely to get more than 6 per cent interest on money paid into a monthly income account. So pounds 5,000 in the Alliance & Leicester 60-day notice account would earn 5.95 per cent gross, while pounds 10,000 would earn 6.10 per cent.

Similarly, pounds 5,000 in Britannia's Capital Trust 30-monthly interest account would earn you 6 per cent, rising to 6.10 per cent for pounds 10,000. With both accounts you have to give notice before withdrawing your cash.

Both are postal accounts, which generally offer the best deposit accounts rates. The drawback with postal accounts is that you are often unable to use the bank's branch offices or be issued with cash cards.

The Bank of Scotland has an instant access account paying 5.75 per cent on pounds 5,000 or above. Halifax Premium Direct Monthly account also offers instant access on a minimum pounds 10,000 deposit at an interest rate of 6.10 per cent, increasing to 6.20 per cent for pounds 25,000. Both accounts are telephone operated. Egg offers the most impressive interest rate at 7.25 per cent.

Some building society bonds, which are essentially savings accounts where you tie your money up for a set period of time, generally one or two years, also pay monthly interest. This should at least protect you against interest rate cuts in the short term. The Woolwich Premier Plus two-year bond pays 6.10 per cent on pounds 5,000, rising to 6.25 per cent for pounds 10,000. The Alliance & Leicester one-year fixed rate bond pays 5.25 per cent monthly.

National Savings have been a common resort for investors looking for regular monthly income from their deposits, but recent cuts in rates have made them less competitive. The Income Bond currently pays 6.50 per cent on investments between pounds 2,000 and pounds 25,000, but this will fall to 5.75 per cent on 3 February. Investments of between pounds 25,000 and pounds 250,000 earn 6.75 per cent interest, which is set to fall to 6 per cent. The National Savings Pensioners Bond pays 4.5 per cent, fixed for five years.

Brian Dennehy, an IFA in Chislehurst, Kent, says recent cuts in National Savings rates make them a less attractive option. "You might as well write them off. With their rates they are more or less saying: 'We don't want your money.'"

Gilts are another option for cautious investors. They are issued by the government and promise a fixed rate of interest (paid twice yearly) for a set term, say five, 10 or 15 years. They are highly secure and can be bought through a stockbroker or the Bank of England.

Falling interest rates make gilts more attractive. They are traded on the stock market and rise and fall in value as interest rates fluctuate. When interest rates are falling, existing gilts rise in value because they pay higher interest than newer issues.

Mr Dennehy says rather than buying an individual gilt, it may be better to buy a gilt fund, where a manager buys and sells a number of different gilts. These funds may include both a range of corporate bonds as well as gilts. Corporate bonds are similar to gilts in that they are issued to raise money, but by large, quoted companies instead of the Government.

Contacts: Alliance & Leicester, 0845 608 8860; Bank of England, 0171- 862 6500; Bank of Scotland, 0500 804804; Britannia, 0800 132304; egg, 0845 600 0292; Halifax, 0345 263646; Woolwich, 0800 222200.