Put your cash on the bank

Savers angry that their bank is paying so little interest may find they are better off buying the bank's shares instead.

Interest rates have fallen so far that most instant access savings accounts now pay less than 1% per annum. Even the best accounts, which often demand you go online, pay little more than 4% gross, and most will be cutting rates further at the end of this month in response to the recent Bank of England cut.

Yet buy the shares of the bank, and you may be in line for dividends that easily beat the interest rate on savings. For example, Lloyds TSB pays only 0.25% interest on its instant access account, and even its best account - a cash Isa - pays just 3.5% with a maximum investment of £3,000.

But holders of Lloyds TSB shares are in line for a dividend payment equal to nearly 9% after the bank announced its results last week. As our table shows, other bank shares are typically yielding around 5%, while one, Abbey National, is on an improbably high yield of 12%.

A quick glance at Jobs & Money's Popular shares table (see page 21) reveals a raft of stocks yielding above 6%, such as Aviva (Norwich Union), Rolls-Royce, Scottish Power and United Utilities.

So should you swap your savings accounts for bank shares or other high yielding shares?

First be cautious about the yield figures quoted in newspapers. The yield on shares is calculated by expressing the dividend as a percentage of the share price. But share prices move, and dividends can be cut, so what looks like a mouth-watering yield can leave a nasty taste.

Take the example of Abbey National. Its 12% dividend yield reflects the dividend payout last year, rather than the unanimous view in the City that the beleagured bank will slash its dividend when it reports a record loss on Wednesday. The prospective yield is likely to be 4%-5% or even lower.

But fund managers say Abbey is the exception. David Jane, manager of M&G Financials unit trust, says: "The Abbey dividend has gone. But if you look at the banks without big life divisions, such as Barclays and RBS, you have to be very negative on the future profitability of these organisations for the dividend not to be secure." At Schroder Income, fund manager Humphrey van der Klugt says the decision by Lloyds TSB to hold its dividend is a positive sign. "It is extremely encouraging that Lloyds TSB has maintained its dividend. Companies are fighting hard to maintain dividends and know how important it is for investors, although the risk of cuts has not entirely gone away."

Schroders are not particular fans of the banking sector - holding around 13% of the Income fund in banking stocks compared to the their FTSE weighting of 20% - but it likes HSBC, which is the fund's major play in the banking sector.

No financial adviser would tell investors to put their faith in a one individual stock. Instead they recommend investing in an equity income fund, which currently offer yields of around 4-5%. The most popular ones currently are sold by Credit Suisse, Invesco Perpetual, Rathbone, Liontrust, New Star, Schroders and Jupiter.

Liontrust believes investors have a once-in-a-generation chance to make money from equity income funds. "This is a no-brainer. This is a window that is bound to close before long," says marketing director Jonathan Harbottle. Normally, Liontrust's income fund manager Jeremy Lang can rely on finding only a handful of decent stocks which yield more than 2% over the long-dated gilt (currently 3.75%). Now he can find around 100 stocks yielding more than 5.75%.

"Only twice in the past 30 years has one been able to build a portfolio with such a wide choice of high-yield stocks available - in 1974 and in 1990-92 at the time of the first Gulf War. If you had balls of steel and bought stocks then, your portfolio did exceptionally well. The same principle applies now."