Premium bonds: a safe bet for your savings or just a waste of time?

http://www.theguardian.com/money/2015/may/30/premium-bonds-safe-savings-waste-time

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If you are one of the UK’s 21 million premium bond holders and haven’t had much luck, you may be convinced that you need to have a big sum invested to be in with the chance of winning the £1m jackpot. Yet, as recently as January this year, a woman from Leeds struck lucky and bagged the top prize with just £400 in total holdings.

But while this is proof that such a win is possible, it is rare. Generally, the more you have invested, the greater your chances of winning a prize.

Each month, the government-backed National Savings and Investments gives away two £1m prizes, a handful of £100,000, £50,000 and £25,000 prizes, and millions of £25, £50 and £100 prizes. In the May draw, Ernie (the electronic random number indicator equipment) produced the numbers that paid out more than 2m prizes worth about £60m.

The maximum you can have tucked away rose from £30,000 to £40,000 last June, and is due to increase to £50,000 on Monday. But even if you have the maximum invested in these lottery-style products (although there’s no risk of capital loss), you may go months or years only getting the odd £25 or £50 prize. So what are the odds of winning?

“For each draw, the odds of a single premium bond winning the £1m prize is 26.7 billion to one,” says Martin Bamford of financial adviser Informed Choice. “The best way to understand this to imagine flipping a coin 34 times and getting heads each time. The odds do improve when you hold more bonds; if you hold £40,000, your odds of winning a prize in a given year are one in 55,643. That said, you shouldn’t count on them to make you wealthy.” According to NS&I, the odds of winning a prize with each £1 bond stands at 26,000 to one.

For every 20 people with £100 invested over a year, 19 must win nothing for one person to win more than £25

Johanna Gornitzki of MoneySavingExpert says: “Each £1 bond has an equal chance of winning a set prize, which can range between £25 and £1m – or, most likely, nothing. But unlike a savings account where you have to pay tax on savings, the prizes are tax-free.”

The nearest thing premium bonds have to an interest rate is the “prize fund rate” – the average that people will win – which is 1.35%. “As the average return of 1.35% is tax-free, this equates to a return of 1.69% for a basic rate taxpayer and 2.25% for a higher rate taxpayer,” says Patrick Connolly from adviser Chase de Vere. “These rates are competitive in the current savings market.”

The problem is that these are average returns and there are no guarantees. “Some people will earn considerably more than this, and many will earn much less – or perhaps nothing at all,” Connolly says.

Gornitzki points out that the way the prizes are allocated means that most people will receive a return that is less than the prize fund rate. “In practice, it is impossible to get this rate as the smallest prize is £25,” she says. “In fact, for every 20 people with £100 invested over a year, 19 must win nothing for one person to win more than £25.

“The most powerful psychological sell of the bonds is that the interest is called ‘winnings’. With £10,000 squirrelled away, you should win at least £100 a year in interest; the same money in a top cash individual savings account paying 1.5% would win £150 a year.”

NS&I itself, for example, is currently paying 1.5% on its no-notice Direct Isa. Nonetheless, with savings rates low, some savers are willing to chance lower returns as they don’t feel they are missing out on much interest.

“There is always the chance that they will actually win a significantly bigger return,” Connolly says. “However, the worst scenario for investors is that they don’t win any prizes and then get their money back. While this might not sound too bad, inflation can have a big impact on the spending power of your money over the longer term.”

So are the bonds worth a punt? “They are only worth considering if you’ve filled your Isa allowance, used a high-paying current account for some of your other savings, and still have some left over,” Gornitzki says.

The only exception is for higher rate taxpayers seeking a safe place for cash. “Premium bonds work best for these individuals as they may get a better tax-free return on their winnings than they would on a cash account after interest has been deducted,” says Danny Cox from adviser Hargreaves Lansdown.

Premium bonds also work well as a temporary home for cash. “This might be a lump sum you have set aside to pay a tax bill or to finance a house purchase,” Cox says. “You may want to put the money into bonds with the hope that the winnings will beat the net interest from an accessible cash account. You can then cash in the bonds whenever you wish without notice.”

Premium bonds remain popular among parents and grandparents looking for a gift for young children, but the minimum investment is £100 (or £50 if you buy the bonds by standing order or bank transfer).

Crucially, premium bonds are not suitable for those who need to generate a regular income or who are worried about the long-term effects of inflation.

Contrasting accounts

The good Alex Jones from Maida Value in west London has had the maximum £40,000 invested for around 12 months and has yet to win a big prize.

However, despite only winning £25 prizes, plus one £50 prize, the 37-year-old, who works in marketing for an insurance firm, has made around £450.

“While I haven’t won a super-big prize, I was using premium bonds as an easily accessible holding place for part of a flat deposit,” Jones says. “With interest rates still at rock bottom, I opted for bonds as, for me, the chance of winning more outweighed the ‘lost’ opportunity of earning only fractionally more money in interest on a standard savings account. And my winnings have certainly been useful, helping me to cover my mortgage broker fees.”

The bad Twenty years ago, when Guardian journalist Hilary Osborne was still at university, she was lucky enough to come into a bit of money.

“I was very fortunate – my dad had been saving with the man from the Pru for years and an endowment in my name paid out (back when you actually got back more than you paid in) and a few hundred pounds landed in my bank account,” she says.

“Despite having loans, I thought I’d put this lump sum somewhere – these were the days when savings earned interest and student debt was pretty cheap, and it seemed a reasonable thing to do. I’m ashamed to say I put some in building societies hoping that they might be converted to banks and bring me a windfall, but a large lump – £500 – went into premium bonds.”

Two decades on, the 38-year-old says she can just about remember daydreaming about whether she would finish her degree if she landed £1m. Almost as distant is the memory of last winning a prize.

“In total I’ve landed about £100 – which may sound good, but works out at an annual interest rate of just 1%. In contrast, one of my building society gambles paid off and I doubled my money (although it remains in the account to this day), while shopping around for savings accounts has given me better returns than bonds.

“The one thing that keeps me invested is the thought that I might one day hit the jackpot. In the meantime, any letter postmarked Glasgow brings a flurry of hope followed by mild disappointment.”