Savings bonds may be just the ticket

If you've decided that opening a savings account is a good way to maximise your income, you may be somewhat disheartened with the low interest rates currently on offer. Certainly, they're not exactly what they used to be - with the interest rate resting somewhere below one per cent in many institutions, you may be thinking it's just not worth it at all. If that's the case, it may be better to investigate savings bonds instead.

With an Individual Savings Account, or an ISA, you have flexibility in that you can withdraw money at any time. The downside is that, currently, interest rates tend to be rather low. Savings bonds differ because the money is held on deposit, and interest is accrued that way. As the money is considered a deposit, the account holder is unable to remove it for a specified length of time.

The timescale is decided at the time of the account opening and typically is one, two, three or five years. The interest rate is set at the time of opening, but the longer the timescale the higher the interest will be; for instance, a five-year option can generate in excess of five per cent interest in a year. If you have the option of a longer timescale and are happy to have your money secured for that length of time, the interest may be higher still. The best savings rates are secured on the longer fixed timescales, so for those who want to generate the maximum amount of money, this is the way to do it. Further differentiation from an ISA is that annual interest is not paid to the account holder but is lumped in with the money already deposited.

While it was stated above that money cannot be withdrawn, there is a small consideration to be made. Most of the time in a savings bond, the holder is given a limited number of times they are allowed to make withdrawals; so it is possible to take money out, but only a limited number of times. Moreover, this usually comes with the penalty of losing some interest, so it is better if possible to leave the money where it is.

The interest rates on savings bonds are undeniably more appealing, but before taking the plunge into opening one you need to ask yourself some important questions. For instance, will you need the money soon? There's no point opening a five-year savings bond if you plan to withdraw the cash in six months to take a holiday. If you do need the money but can't access it and subsequently decide to borrow money, the cost of repayment will far exceed the return on your savings bond. With this in mind, it is easy to get sucked into a false economy and end up potentially worse off than you were before opening the bond.

It is also important to not be too optimistic regarding interest rates. This means if you take out a bond with a five per cent interest rate today, don't expect that to hit seven per cent two years down the line. The fact is that no one, including bankers and analysts, knows what the interest rates will be like in the future. This isn't necessarily a problem, provided you are prepared to leave the money and let it grow by however much it does. It may become a problem if you expect wild sums of money to be available at the end of the bond timeframe, though.

Another thing to consider before jumping into a savings bond is whether you will need access to the money for other things. It was already mentioned that it's not wise to start a bond then plan a holiday with the money, but perhaps more importantly it must be remembered that the cash will not be available to use in other profitable ways. This means it is pertinent to be in a decent financial position from the outset, or at least have other funds available, as money in a savings bond will not be available for clearing a mortgage or investing elsewhere.

There are pros and cons of savings bonds. If you have some money set aside you want to save and have no plans for, take advantage of the higher interest rates offered with savings bonds.