Earn an extra £220 a year on your savings

You can earn a much better rate of interest on your savings if you're willing to lock your money away in a fixed rate savings bond. But is it a good idea?

Who'd be a saver? The last few years have been pretty rubbish for those people who have worked hard to put aside a decent stash of cash in savings, only to see interest rates plummet.

With easy access savings accounts providing such utterly pitiful returns, your best bet may be to lock that money away for a while in a fixed rate bond.

What is a fixed rate bond?

With a fixed rate bond, you lock your money away for a set period - and in return, you should get the security of a fixed rate which is likely to be higher than any you'd receive on easy access savings accounts.

But bonds come in lots of different shapes and sizes. How do you figure out which one to go for? The answer depends on a couple of big questions you have to ask yourself. The first, of course, is how long you can cope without that money. If you're like me and only just in the process of building up a savings safety net, you probably can't afford to risk that money being out of reach for much longer than a year.

However, if you already have a decent stash set aside for emergencies, and you still have plenty of savings left over, you can probably afford to put that money away for a bit longer - and it's the longer term bonds of course which pay the best rates of interest.

That's where the second question comes in - what do you think will happen to interest rates?

This is crucial, because if you plump for a five-year bond, and a year down the line Bank Base Rate has jumped up to 5%, you'll be kicking yourself.

Here at lovemoney.com, we have put together a terrific round up of what the great and the good reckon will happen to Bank Base Rate in What the future holds for interest rates, but in the end you have to make your own mind up on how long to put your money aside for.

Short-term fixed rate savings bonds

Personally I would not want to lock my money away for anymore than a year, two years at the absolute maximum, because I think interest rates will be on their way up within a year.

If you take a similar position to me, you might want to consider the bonds below, which are the best available if you only want to put your money aside for a relatively short space of time. I've excluded the (many) deals which require you to be an existing customer, open specific additional accounts and generally jump through hoops.

One thing becomes immediately clear looking at the table above - none of the market-leading rates come from outfits you are likely to see on your high street.

What's important to remember is that each of the banks listed are members of deposit protection schemes - both the Punjab National Bank and the ICICI Bank are members of the UK Financial Services Compensation Scheme, while the Bank of Cyprus is a member of the Cypriot Deposit Protection Scheme, which covers the first €100,000 (about £88,400).

This means that you should feel relatively comfortable banking with them.

A one-year savings alternative

If you only have a small amount of savings you want to get a decent return on, then you might be better off going with the Alliance & Leicester Premier Direct Current Account, which pays a fixed rate of 6% on balances of up to £2,500 - as long as you deposit £500 a month.

Because it's a current account, however, it's instant access, so this best strategy is to keep a balance of £2,500 in the account, but to transfer £500 in and then out the next day, each month, by standing order. Read more about this in Earn 6% on your easy-access savings.

Ok, so it's a bit of a fiddle, but if you are willing to put up with moving your money around a bit, you'll be rewarded with a fixed interest rate almost double that of the best one-year bond! Plus you'll get instant access to your cash whenever you want it. So if rates do start to rise elsewhere, you can access your money quickly. 

Long term savings bonds

Of course, you may be of the opinion that interest rates will stay low for a far longer period, and prefer to go for a longer term deal.

Obviously, you will get a better rate of interest than shorter bonds, but it is a real gamble. The economy can change an awful lot in five years.

Is a fixed rate savings bond worth it?

Now, let's say you have £1,000 in savings. If you put it in the market-leading easy access savings account, from Coventry Building Society, you'd earn a variable raet of 3.3% AER. So, in a year's time, if its rate stays the same, you'll have £1,033 in the account.

Go for the one-year bond from the Punjab National Bank, paying 3.75%, and in 12 months you'll have £1,037.50. An improvement of just £4.50 before tax, and you've had to put up with the inconvenience of not being able to access your cash.

What about if you stick that money in the market-leading five year bond from Aldemore, paying 5.15%? In 12 months you'll have £1,051.50. So again, a small return - just £21.50 more than an easy access savings account.

And bear in mind that, with this bond, your money is locked away for a further four years and, if interest rates rise as expected, much higher rates may be offered during that time.

Of course, £1,000 is a relatively small sum of savings. The difference becomes much more pronounced if you have a serious amount of savings locked away.

If you instead have a sum of £10,000 in savings, then you'd earn £330 in interest from the Coventry in a year's time, if its rate stays the same. Go for the Aldermore account, and you'll instead be looking at a return of £510 - an improvement of £220 a year!

So, for larger sums, the difference between an easy access savings account and a fixed rate bond is far more significant. Having said that, the long-term bonds just don't look so great that I'd be tempted to lock my money away for five years. I'd definitely stick with short term deals at least for the next year, as you'll probably then have a choice of far more attractive looking deals.

Get help from lovemoney.com

If you want to make 2010 the year of saving, there are a host of ways lovemoney.com can help.

First off, you might like to follow some of the hints and tips in this goal: Build up your savings

Next, have a look at this video: Wave goodbye to your overdraft forever

And finally, if you have any questions about getting into the savings habit why not pick the brains of your fellow lovemoney.com readers in our Q&A section?

More: Earn £235 more on your savings this year! | Beware of these 5 terrible savings traps!