In theory it’s not too bad; a diversified portfolio of investments with actuarial ’smoothing’ applied to deliver less volatility to the investor. In practice it can be a nightmare.

Even as world stock markets continue their recovery, With Profits funds are likely to remain behind the curve (again). Recent research from exitwith-profits.co.uk suggested that up to five million people are invested in With Profits policies that are “doomed to fail”. That’s a lot of potentially disappointed investors.

There are three main ways to lose when you invest in With Profits. Understand them and you put yourself in a much better position to make good investment decisions for the future.

1 – Low or nil annual bonuses

When you invest in With Profits, part of the reward for investing should be an annual bonus. These are applied by the insurance company once a year, depending on how the With Profits fund has performed and how generous their actuary is feeling.

A valuable feature of these annual bonuses is that once added, they cannot be removed. This is as long as you continue to satisfy the terms and conditions of your With Profits policy.

Unfortunately, the insurance company is under no obligation to actually pay an annual bonus each year. When times get tough and investment markets fall in value, the annual bonus is usually one of the first victims.

Depending on the individual With Profits fund, you might not receive an annual bonus at all. Of the 39 insurance companies who operate With Profits funds, several are not currently paying an annual bonus to policyholders.

Investors in those With Profits funds paying a nil or a low rate of annual bonus need to question whether they could get a better return elsewhere over the longer term.

2 – Reduced final bonuses

Whilst the annual bonuses (when added) to your With Profits policy are guaranteed not to be taken away in the future, the final (or terminal) bonus can be removed or reduced without warning.

These final bonuses can make up a large share of the total return you might get from investing in With Profits. Recently we saw some of the funds managed by Phoenix remove the final bonus altogether. Last month Standard Life cut the final bonus payments by around 9% for pensions and 18% for endowment policies.

Hanging in there for the prospect of a juicy final bonus is a factor that encourages some investors to overlook miserable annual bonus rates. It is important to understand that your terminal bonus can go up in smoke on the whim of the insurance company.

3 – Market Value Reductions (MVRs)

These are the bane of your life when you want to leave the insurance company and start elsewhere with a different investment strategy. Designed to ensure that you do not leave the With Profits fund with more than your fair share of the assets, MVRs can be a strong disincentive to leave the With Profits fund at all.

When the global financial crisis really kicked off last autumn, a number of insurance companies were quick to impose MVRs or increase existing MVRs. The cynic in me thinks that these are now used as a device to encourage With Profits investors to stay put, rather than as a tool to ensure fairness to policyholders who remain invested in the fund.

MVRs of up to 30% have been applied to With Profits policies. Investors faced with the prospect of penalties of this magnitude have a really tough choice to make, particularly if this is combined with low annual bonuses and a risk to final bonuses.

In some cases it can be worth ‘taking the hit’ of an MVR, assuming you have long enough left to remain invested and the possibility of rebuilding your fund in a less opaque investment environment.

Some final thoughts

Not every With Profits fund is that bad. A few have actually managed to do what they originally set out to achieve; provide low volatility returns combined with exposure to the sorts of investment performance you might expect from the stock market.

It is also important to remember that some With Profits policies come with valuable guarantees, such as a final fund value, guaranteed annuity rates or ongoing annual bonus level. These are never to be given up lightly, but you should always consider them in the context of the other factors described in this article.

If you are thinking of getting out of With Profits then you should always seek professional independent financial advice first.

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice.

In the current climate there is no simple way to get better returns without taking more risk with your capital. The only real solution is to shop around for the most competitive rate of interest and keep this under regular review.

There are several ’savings traps’ that make the hunt for a better interest rate more challenging. The higher headline rates on some best buy tables might look attractive, but always read the small print to make sure you avoid the following pitfalls.

1 – The introductory bonus

Quite often the highest rates of interest include an introductory bonus that only lasts for a short period of time. This can vary and may be as long as a year, but when it runs out the chances are your interest rate will revert to a less competitive level.

Banks and Building Societies use these introductory bonus rates to bring in new customers, because they know that for the majority of savers apathy will rule the day. Once the bonus period comes to an end, they will hang on to most of the savings business because their customers will not bother to move their money.

Introductory bonus rates are great if it means you can get the best rate of interest on your cash and you have the discipline to do your homework again when the rate comes to an end. Always make a note in your diary when you open the savings account with an introductory bonus rate and remember to shop around again to keep your interest rate competitive.

2 – Buy one of our lovely investment products

For the past few months the various best buy tables for fixed term savings accounts have been plagued by what looks at first glance like a series of very attractive interest rates. These great rates come with a nasty condition; you have to invest the same amount that you save in an investment product from the bank.

These are not just investment products but the type of investment product you would be slightly bonkers to consider using. These structured products tie up your money for several years, tend to disappoint in terms of actual returns and come with several hidden risks to your cash.

If getting the best savings rate is dependent on investing some of your cash as well, move swiftly on to the next best rate on the best buy table.

3 – Open a linked current account

Some banks will insist that you open a current account with them to benefit from the interest they pay on their competitive savings account. They ask that deposits and withdrawals into your savings account are made via your shiny new current account with them.

In most cases there is nothing wrong with this. Always read the small print to make sure there are no hidden banking charges on the current account to quickly eat up the benefit of the interest on your savings account.

Having to open a current account to get access to the competitive rate of interest on the savings account is usually nothing more than a mild inconvenience.

4 – Existing/new/local customers only

The small print on some competitive savings accounts includes restrictions on who can open an account. Some of the very small mutual Building Societies limit their accounts to savers who live very close to the branch. In practice you probably wouldn’t want to open an account with one of these institutions if the only way to interact with them involved a lengthy drive to the nearest branch.

Other accounts are restricted to new or existing customers only. Most banks and Building Societies are pretty upfront about these restrictions and you should not have to delve into the small print too far to find them.

5 – Fixing just before interest rates go back up

With interest rates currently so low, they are bound to go back up again at some point in the future. Nobody knows precisely when this will happen, but the smart money is on rates going back up at some point in the next twelve months.

If you have the choice between an instant access savings account and a fixed term account paying a more competitive interest rate, it can be tempting to opt for the latter. The rule of thumb when it comes to savings is that you get a better rate of interest when you are prepared to tie up your money for longer.

Make sure you do not lock your money away at relatively low rates of interest for too long and then miss out on rising interest rates. A one year fixed rate is probably safe, two years would be risking it and three years means you are more than likely to miss out.

6 – Lower interest when paid monthly

If you rely on your savings interest to supplement your income then you probably need to get that interest on a monthly basis. The most competitive savings accounts typically pay interest annually. Some of the fixed term accounts do not add interest until the end of the account term.

If you need monthly interest then compare interest rates on accounts which pay interest monthly. It sounds simple but it is often overlooked in the hunt for the most competitive interest rates.

7 – Tiered interest rates

What you see is not always what you get when it comes to interest rates on savings. The practice of ‘tiered’ interest rates means you may not get the high headline rate of interest on the entire balance of your savings.

Some of these accounts pay nil interest on the first part of your savings and then increasing levels of larger amounts. The net result is often a lower total interest rate than that advertised as the headline rate. In fairness, these accounts usually also come with a minimum deposit requirement, so as not to attract small savings pots which would not benefit from interest.

8 – Hanging onto your cash

Some instant access savings accounts come with a nasty bit of small print to effectively penalise you if you exercise that right to instant access. They pay you a much lower rate of interest in the month you make the withdrawal. This is akin to a withdrawal penalty and can result in a smaller interest payment at the end of the year.

If you need instant access to your cash and you are likely to make withdrawals during the course of the year, look for a savings account that does not penalise you for taking your money out. Some fixed term savings accounts even allow one or two penalty-free withdrawals during the course of the account term.

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice.