With interest rates now the highest they’ve been since the Global Financial Crisis (GFC), are Premium Bonds still worth it?
The answer depends on who you ask. With Premium Bonds, it has long been considered that there is no risk to your capital, it is only the ‘interest’ element that is a gamble. And as Premium Bonds are operated by NS&I which, rather than being a bank, is backed by the Treasury, this capital is as safe as possible. However, with inflation now peaking at over 10%, the underlying capital is losing purchasing power in real terms – a silent erosion of your investment.
This safety used to be advantageous because you didn’t get the same protection with other savings. However, now all UK-regulated savings accounts are protected up to £85,000 per person, per institution, by the Financial Services Compensation Scheme (FSCS) – and the maximum you can put in Premium Bonds is £50,000.
But don’t you have to be ‘In It To Win It?’
Each month, NS&I posts the equivalent interest rate of Premium Bonds based on the average winning. Due to interest rate rises, this has now increased to 3.7% – much higher than previously, but considerably less than the 6.15% interest offered by Vanquis Bank on their top 1-year fixed rate account, even taking in to account the fact that the interest is taxable.
However, Premium Bonds offer the chance of winning £1million tax free, so is that worth sacrificing up to 2.45%. After all, ‘you have to be in it to win it’. Premium Bonds aren’t dissimilar to the Lottery in that both offer their patrons a chance of walking away a millionaire. But is it as clear cut as it first appears?
The 3.7% rate advertised describes the average, indicating that for every £100 paid into bonds, on average £3.70 a year is paid out – yet in practice this is impossible, as the smallest prize is £25. In fact, the Premium Bond Probability Calculator shows if 20 people each had £100 invested, for one to win £25-plus, the remaining 19 would have to win nothing.
A far better indication of what someone with typical luck would win is the median or the ‘middle figure’. Based on actual records, should you manage to line up everyone with £1,000 worth of Premium Bonds, the person halfway along would have won… nothing! In fact, you’d need to walk past 60% of the line until you hit the first £25 winner.
And what about the chance of winning the coveted £1,000,000 jackpot? Per £1 bond invested, the odds are a staggering 1 in 5,061,123,185 – 1 in 5 BILLION. Should you hold the maximum £50,000 your odds improve greatly to a modest 1 in 1,331. Even these wealthy few still have a chance of earning nothing in a year and, with inflation projected to be 8% this year, this would be a real terms loss of £4,000. Luckily for them, there is only a 1 in 72,042,995,260 – 72 billion – chance of that happing either.
Which begs the questions, are Premium Bonds worth it?
Premium Bonds may make sense for certain situations. Premium Bond prizes are tax-free, but so is savings interest for 95% of people. Yet if you’re one of those who earn more interest than your personal savings allowance, then if you’ve a decent amount in bonds, they’ll usually be the clear winner (especially as cash ISA rates are still below 4%).
A lot of appeal surrounding Premium Bonds is the mentality surrounding the way the return is paid. The lottery-effect hooks you into the unlikely dream of bagging a million-pound prize. However, for most people this is not the reality – you’re actually likely to get less than a guaranteed 3.7%, and there’s a negligible chance of winning a million.
If you know and you’re OK with this, then investing in Premium Bonds isn’t a bad plan.
As Clint Eastwood in Dirty Harry might say, the question you’ve got to ask yourself is ‘Do I feel lucky today?”.