Binding yourself to local bonds means losing cash

Most local authority IOUs are like civil servants: dull, but reliable. You can get higher returns elsewhere

Local authorities are there to clean the streets, collect your rubbish and charge you too much for council tax. Few people realise several authorities also issue investment bonds that allow you to earn a fixed rate of interest for minimal risk.

Local authorities are there to clean the streets, collect your rubbish and charge you too much for council tax. Few people realise several authorities also issue investment bonds that allow you to earn a fixed rate of interest for minimal risk.

Several years ago, local authority bonds were relatively big news, used by tens of thousands of investors. Local authorities issued them as a way of borrowing money to help pay for local services, in the same way as the Government borrows money by issuing gilt-edged securities or private companies raise money for expansion through corporate bonds.

"The money raised has traditionally gone on paying salaries, running local services, instigating witch-hunts and all the other things for which local authorities are renowned," says Martyn Page, head of research for Countrywide Independent Advisers.

The bonds pay a fixed rate of interest for a set term, and are serviced from income earned from council tax payments. They have typically been used by cautious investors, who see them as a low-risk source of interest because they are backed by the local authority, and by implication central government.

But the price you pay for higher security is a meagre return, especially in these days of low interest rates. "You could do much better elsewhere for only a marginally higher level of risk," says Mr Page. Typical bonds are issued for between two and five years, and pay interest every six months. Minimum investment is between £500 and £2,000, with no maximum. Rates change regularly, but Moneyfacts show that at the end of February, Pembrokeshire county council was paying 4 per cent on bonds fixed for between two and four years, and North Ayrshire was paying 5.25 per cent for between three and six years. These are low, but still ahead of inflation, and your original capital is guaranteed. Rates are similar to those paid on government gilts, which have a redemption yield of around 4.8 per cent for terms of less than five years.

National Savings, much criticised for its falling savings rates, does little better, paying 4.9 per cent fixed for two years on a minimum £500 on its Pensioners Bonds Series 9.

"You can get a much better rate by investing in another relatively safe investment, corporate bonds from large, sturdy businesses such as Abbey National and Tesco," says Mr Page. "These are sold through stockbrokers and pay between 6.5 per cent and 7.5 per cent."

Other options include put-ting your money in a fixed-rate bank or building society account. Bristol & West pays 6.1 per cent on £500 or more invested in its Easy Plus account, fixed until 25 October 2001, shows Moneyfacts, and Providian National Bank pays a similar amount on £5,000 or more invested for between one and five years in its fixed rate bonds.

The highest rate you can get is through a cash Isa. Internet bank Smile pays 6.75 per cent on £1 and above, and Chelsea Building Society pays 6.5 per cent on £10 and above. These rates are variable and will almost certainly fall, if interest rates are cut further, as many expect.

The other drawback with local authority bonds is that they are increasingly rare. They are offered by only eight local authorities, and two of these, Blackpool and Sefton, are bowing out. The others are not seeking new business with enthusiasm. Nottingham city council still offers bonds to more than 3,000 savers. Six years ago, there were 20,000, when its rates were more competitive. Peter Guest, the treasury management officer, says bonds are no longer the best way for authorities to raise funds. "We can access fairly cheap rates through the Public Works Loans Board, and now we offer bonds as much as a service as a source of raising money."

The council pays 4.25 per cent on bonds fixed for between two and five years. Many of those buying the bonds are elderly investors who have been saving with their local authority for years. "They feel safe with us, and they can visit to talk to us about their investment, which gives them the human touch," says Mr Guest. "It is also more straightforward than setting up a postal, telephone or internet-based savings account, and if you want a safe home for your money for a couple of years, you could do a lot worse.

"Local authority bonds are as safe as you can get because the government would effectively step in if the local authority ever got into financial difficulties. It is hard to choose between local authority bonds and gilts for overall security. Most of our investors save relatively small amounts. We have nothing bigger than £25,000, which is probably a good thing, because with this amount you should be able to get much better value for money elsewhere."

Gordon Whitehead, principal accountant at Oldham metro-politan borough council, says bonds are a service to the community. "We offer bonds to those who want them but we don't tout for business. We still have several hundred thousand pounds invested, but we are not looking for a flood of new inquiries." The other authorities offering bonds are Torfaen council in Wales, and High Peak borough council.

But if you have money in a local authority bond, do better by switching when the investment term expires. Unless security is more important than getting the best return.