State Savings analysis

Introduction

On the 1st October the interest rate for State Savings will increase.

Switching Beware

We analysed the State Savings Holdings of a client to assess if they should cash them in or keep them.

Intuitively, if you can get a better return elsewhere, most people would cash in without giving it a second thought.

However, the terms and conditions of State Savings Certificates are such that you really need to carefully assess how long until the next anniversary date and how long until maturity to make a decision.

Example

James holds the 10 year State Savings Certificate issue 5. This is the 2015 product which was issued with a total return of just 25% over 10 years.

Now, we would never recommend anyone takes out a 10 Year State Savings Certificate unless it was 1990 and interest rates were up at 15%, but James already purchased the chocolate teapot and so we have to figure out what's best for him.

As we can see from the table above the interest payable is heavily skewed to the last few years. James bought it in 2015 and only has 1 and half years left to run.

The uplift in his return from waiting until the next anniversary in 182 days time is equivalent to an annualised interest rate of 12.36%. This is because he doesn't have to wait a full year to earn an additional 6% as he moves from the 8th to the 9th year.

Obviously, we can't guarantee a 12.35% AER from anything else and therefore James should stick with it. In the final year the additional interest is also a healthy 7% and, of course, this is also tax free.

James would need a bank account paying over 10% Gross to pick up that return net of DIRT.

So, our advice in this particular example is that even thought James should not have bought the 10 year Savings Cert back in 2015 because of the terms of this product he is better off sticking it out now for another 18 months.

Irish Government Bonds a better alternative?

So, what about someone contemplating taking advantage of the new issue of State Savings Certificates. Are they a good investment now that the rates are finally being increased?

Well, again, it really depends.

Let's compare 3 different terms of certificates with the equivalent Irish Government Bond.

Increases in interest rates mean falling bond prices and rising bond yields. Interest rates have increased rapidly in the last year and this has had a dramatic effect on bond prices causing many bonds to trade at a discount.

Example 0% Treasury Bond 2031 is currently (15th September) trading at 78.99. It is due to be redeemed on the 18th October 2031 for 100. Meaning that there is a gain of 21 Euro currently built into the price. That equates to an annualised return of around 2.96%pa before costs. Dealing and custody charges equate to an annualised cost to be deducted from this gross return of around 0.275%pa.

Capital Gains on Irish Government Bonds held by Irish Residents are free from tax so if you select a short-dated Irish Government Bond it is possible to currently receive a higher tax free return if held to maturity than the equivalent State Savings Certificate.

Whilst these are not directly comparable (State Savings are accessible with 7 days notice and have no transaction or holding costs) and there is a risk of capital loss with a Government Bond as well as possible risk of default, it should be clear that recent increases in interest rates have not been passed on to savers in the same way that yields have adjusted in capital markets.

If you have at least 100,000 Euro and you are contemplating State Savings as a way of diversifying your investment portfolio and are happy to hold to maturity then at current yields Irish Government Bonds are offering a better proposition.

Whereas, if this is rainy day money that you really can't afford to lose, then putting it into a 3 or 5 year certificate accessible at 7 days notice is probably better than a bank account especially if you don't touch it for at least a year.

For information and educational purposes only. Not a recommendation to purchase a particular security.