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Are Premium Bonds a good investment?

Image of two dice, to illustrate the random nature of Premium Bond investing.

I know I’m a contrary so-and-so, but even I was aghast to discover I’ve been eschewing Britain’s most popular savings product.

It turns out the great unwashed are agog over Premium Bonds, the state-sponsored jackpot racket run by National Savings & Investments (NS&I).

The £47 billion of promises to tomorrow and postponed daydreams that the masses have stashed away in Premium Bonds make them the nation’s most popular way to save, according to The Telegraph.

But not I – I have stood aside.

Indeed for most of my adult life, Premium Bonds have been a bit of a joke among the investing cognoscenti that I like to pow-wow with over Mai Tai cocktails in Mayfair’s most exclusive member’s clubs – something owned by maiden aunts who feel they’re overdue some luck, and by unlucky grand kids who would have been better off with envelopes stuffed with cash.

Indeed as my top pals Biffo the city broker and Over Easy the currency trader used to banter while jousting with rolled-up copies of the FT across the pool table, only a fool would buy Premium Bonds for a grab at the million pound prize.

“The smart thing to do, if you must be an insufferable member of the punting hoi polloi,” chirps in Erinaceous the hedge fund manager from his perch atop the club room’s antique rocking horse, “Is to put your money into a normal high interest savings account, and then use a certain amount of the interest you get from that to buy National Lottery tickets.”

Wise words!

In the halcyon days of mine youth, it was easy to get 5% interest – and sometimes much more – on cash on deposit, if you were halfway savvy about where you ferreted away your savings.

In contrast, the effective interest rate on your Premium Bonds with average luck was far lower.

National Lottery tickets cost a mere pound. You could buy dozens of the blighters with the interest on your savings on a Saturday morning, chance your arm on the Lotto’s superior odds via half a dozen lucky dips, and still make it to Rules for second breakfast.

Ah, those were the days.

Alas interest rates have been well and truly savaged by those pink-hued rascals at the Bank of England, and that has thoroughly filleted the juicy spread between the rate paid by NS&I on its Premium Bonds and what you can get from Captain Mainwairing at your local bank.

I concede you can still sniff about and score 3% or so on cash if you can be bothered to juggle half-a-dozen savings accounts like an East End barrow-boy. But really a chap has better things to do with his precious few days of summer than fill in application forms for peanuts.

And – lean in chums – there’s more.

Seemingly keen to hasten Great Albion’s descent into a nation of perfidious gamblers on hock, the good time guys at NS&I are also doubling the million pound bag, from one seven-figure Kahuna Burger of a bond a month to two1.

Thus you now have twice the chance to top up the old trust fund with a cool £1 million bag of swag.

Consider me roused. Piqued, even! I may be the sort of fun-minded fellow who leaves his Russian beauty queen bride at the airport on our honeymoon because I mistake her for a shop mannequin, but I’m not one to turn his nose up at a penny-compounding wheeze of this caliber – not before a closer inspection.

In short: Time to look again at Premium Bonds.

What are Premium Bonds?

Given there’s 47-thousand million pounds invested in Premium Bonds, most of you probably own a few and know at least as much about them as I do.

To recap (and to leave P.G. Wodehouse in peaceful repose):

  • Premium Bonds are a special sort of savings fund administered by NS&I on behalf of the British government.
  • They are backed by the government, so your capital is not at risk from bank runs or similar (but remember all regulated savings accounts are protected up to £85,000 by the FSCS).
  • You can sell your bonds at any time and get your money back in around eight days, which makes them fairly liquid.
  • They are a form of lottery bond, costing £1 each, with a minimum tranche size of £100.
  • The maximum holding of Premium Bonds for any one individual is £40,0002.
  • The effective interest rate on the £47 billion the nation has socked away in Premium Bonds is currently 1.3%.
  • However the bonds do not pay interest. Instead, every bond is entered into a monthly prize draw for cash prizes, which range from the smallest and most common £25 prize up to the £1 million jackpot (two from 1 August 2014).
  • The odds of winning any prize per £1 unit is currently 26,000 to 1.
  • Winnings are tax-free.
  • The bonds were introduced in 1956, and today one in three Britons owns at least a few. A dedicated machine called ERNIE supposedly draws the prizes.

That’s the simple part. If you’re easily seduced, you can tootle off and order some Premium Bonds online from NS&I.

How is the Premium Bond prize money divided up?

Good question, and I’m glad to see you’re not such a sucker for any old 26,000:1 long shot.

The first thing to consider is the prize draw. This varies depending upon, for example, how many bonds are in issue. Every few months NS&I publishes one by way of sample, with the latest coming from February 2014:

 Prize band Prize value Number of prizes
 Higher value (5% of prize fund) £1 million 1
£100,000 3
£50,000 6
£25,000 13
£10,000 31
£5,000 61
 Medium value (4% of prize fund) £1,000 811
£500 2,433
 Lower value (91% of prize fund) £100 12,238
£50 12,238
£25 1,774,483
 Totals for February 2014 £50,765,275 1,802,318

Source: NS&I

The major thing to note from this table is that there are far more small prizes than large prizes. There are just six £50,000 prizes, for instance, versus over 12,000 prizes of £50. The vast majority of winning bonds get £25.

This is the main reason why it’s so hard to calculate the precise odds with Premium Bonds.

What are the chances of winning with Premium Bonds?

If all the prizes were £25, for example, then you could assume that if you bought £26,000 worth of bonds, you’d likely win a £25 once a month with average luck (because the odds of winning a prize are 26,000 to 1). This would give you £300 a year on your £26,000.

However as an interest rate, that works out as 1.15%3, which is lower than the 1.3% advertised by NS&I.

It is the skewed nature of the prize fund that makes up the ‘lost’ interest here – and which makes Premium Bonds a lottery, of course.

It’s actually very difficult to calculate the precise odds of winning. There is no “average” payout, because the smallest prize is £25. Every month, most Premium Bond holders get nothing.

And it turns out that even a £26,000 holding can expect just £250 a year in prizes, with average luck.

As Martin Lewis writes in The Telegraph:

A far better indication of what someone with typical luck would win is the ‘‘the person half-way along’’ measure. Those who can dredge up their school maths will remember this is called the median average.

To best demonstrate this, here’s an extreme example.

Imagine I sold a million people a £1 lottery ticket, and then paid just one winner a million pounds.

I could argue, mathematically, that the (mean) average payout was £1, so on average everyone got their money back. This, of course is bonkers. Almost everyone wins nothing – which is the result you’d discover if you lined them all up and asked the mid-way person.

The Premium Bond prize rate is a lesser version of this: to pay a million-pound winner, many thousands need to earn nothing.

It is possible to do rough and ready calculations on what you’ll likely win, due to the preponderance of £25 prizes.

Let’s say you own £15,000 worth of bonds:

15,000 bonds x 12 times a year at 26,000 to 1 for each bond

(15000 x 12)/26000= 6.92

Is equal to around seven prizes a year, or £175 in annual expected winnings.

However this doesn’t take into account the distribution of higher value prizes, and so is not a precise figure.

Lewis employed a cosmologist to do the multinomial probability maths needed to solve the Premium Bond riddle. The result is his probability calculator, which he claims is run for six hours a month to calculate the latest odds.

It’s a slick tool that will tell you how much you might expect to win with average luck for a given amount of Premium Bonds over 1-10 years.

If you experiment with the calculator – or if you have a degree in mathematics – it will become clear that because of the prize distribution and the lottery nature of Premium Bonds:

  • Most smaller Bond holdings (say £1,000) will win nothing in a typical year.
  • To maximize your chances of getting a smoothed savings-like return, you need to hold the full allocation.
  • The odds of winning the £1 million jackpot are 1 in 47 billion, compared to roughly 1 in 14 million for the National Lottery.
  • However with Premium Bonds you get to keep your monthly stake.

Statisticians have studied exactly why these properties make Premium Bonds so incredibly popular with everyday savers.

Premium Bonds and inflation

Remember that Premium Bonds are not inflation-proofed, so a £1 bond will become less valuable in real terms over time.

You’d have to reinvest your prize money (up to the maximum holding allowed) to try to keep up with inflation, which you can do automatically via NS&I.

However inflation is currently higher than the notional interest rate on the bonds, let alone the rate you’ll get with smaller holdings with average luck, so your holding will probably decrease in value in real terms whatever you do.

This is likely one of the reasons for the persistent myth that long-held bonds win less often, incidentally. A £100 holding that was quite a stash in the 1970s is now unlikely to win for years on end, just because of inflation.

Are Premium Bonds worth it?

Probably not. But there’s one more thing to consider, which is your tax bracket.

Remember that Premium Bond winnings are tax-free. This makes them intrinsically more valuable to a higher-rate taxpayer than a basic rate payer, or to somebody who pays no tax.

You might get 1.5% interest on a Best Buy savings account. But after tax this nets out to just 1.2% to a basic rate taxpayer, and to an even more measly 0.9% for those in the 40% bracket.

As I said in my fanciful introduction, it’s these very low interest rates that make Premium Bonds contenders right now – especially for higher rate payers.

Have a play with Lewis’ calculator, and you’ll find there’s only a negligible chance that higher rate tax payers will do worse in Premium Bonds than if they put their money into a standard table-topping savings account.

However this advantage drops away at lower tax brackets. Ironically many of the legions of pensioners who own Premium Bonds would statistically be better off trading them in for cash savings (assuming the resultant interest didn’t change their tax bracket).

Of course if you’re a savings maven who likes to game the savings system with Santander’s 123 Account, special monthly savings accounts and so on, then you can do far better than the Best Buy rate.

Pensioners will also be able to buy Pensioner Bonds later this year, and they will pay a far higher rate of interest, too.

Locking away your savings for a few years will also deliver a Premium Bond beating rate. But that’s not really comparing like with like, as Premium Bonds can be turned into ready cash at any time.

Are Premium Bonds a good bet?

Premium Bonds will only really be a sensible bet for higher-rate payers with a large slug of cash that they can’t or don’t want to hold in ISAs (perhaps because their ISAs are stuffed with equities and bonds) and who can afford to have a large – ideally £40,000 – holding for the best chance of a median return.

And that’s even after the bonds are modestly sexed-up with the doubled £1 million jackpot, which in practical terms is neither here nor there.

Oh, and please don’t be a conspiracy theorist about whether Premium Bonds are a good investment! The myths and anecdotal inconsistencies all arise from probability, unless you believe the Government is into explicit fraud.

I’ve already cited how the value of small holdings are eaten away by inflation, which makes future winnings from a static holding of bonds ever less likely.

Another reason those with very old holdings may feel such old bonds rarely seem to win if they monitor the monthly results is there are far more newer bonds in circulation. According to NS&I, nearly nine out of ten bonds were bought since 2000. It’s down to probability again.

Another common complaint is that even those with maximum holdings seldom seem to win prizes greater than £25. But have a look again at the prize fund table and bust out your calculators.

Even with a full-sized holding of bonds, you probably can’t expect to win a prize of £500 or greater more than once in an average working life, and there’s no guarantee that you’ll get even that.

Premium Bonds are a lottery. If you want a sure thing, buy gilts!

  1. From August 2014 []
  2. Increased from £30,000 in the 2014 Budget, and set to rise again to £50,000 in Spring 2015 []
  3. £300/£26,000 []
{ 26 comments… add one }
  • 1 Under The Money Tree June 6, 2014, 10:53 am

    I have been drafting a very similar article to this….destined for the trash now!

    I tend to use PB’s as a cash saving device. Given the low savings rates I direct debit a couple of hundred £ each moth to PB’s as a sort of cash buffer. When it gets to a certain size i either invest it properly or use it to pay down some mortgage.

  • 2 Leon June 6, 2014, 11:45 am

    Timely article – I had a rather pleasant win of £25 last month. It was pleasant because I didn’t realise I had a premium bond account!. Neither did my folks when the cheque arrived at their house (where I lived 10 years ago). Our best guess is a relative gave it as a christening gift.

    It makes me ponder how many other’s have unknown accounts with this institution and possibly unclaimed prizes!

  • 3 MrsFinancialFreedom June 6, 2014, 11:49 am

    I don’t own any premium bonds as I’ve always preferred to put it in savings then at least you are guaranteed some interest. My daughter’s grandparents bought her £100 of premium bonds when she was first born and she is now nearly 7 and she has one absolutely nothing. I think I will be given them a miss.

  • 4 bobbyo June 6, 2014, 12:20 pm

    I think your writing (not just the PGW impersonation, tho that was particularly spiffing) is excellent. Just wanted to put that out there…

  • 5 The Rhino June 6, 2014, 12:26 pm

    I think you could add a tl;dr of ‘No’ and it wouldn’t cause too much controversy

    @ MrsFinancialFreedom – what you have there is called the availability heuristic, a cognitive bias applied to a statistical problem. Guess who’s just been reading Kahnemann again..

  • 6 BeatTheSeasons June 6, 2014, 12:37 pm

    A great reminder of why the £5 allocation that someone bought for me when I was a baby has yet to pay out anything in prizes. I’ve not felt tempted to liquidate my small pot, however, as taking the cash isn’t really worth reducing my chances of winning the jackpot from 5 in 47 billion to absolutely zero – you got to be in it to win it!

    The only financial benefit I’ve ever derived from familiarity with premium bonds is cash won at a pub quiz from knowing that ERNIE stands for “Electronic Random Number Indicator Equipment”.

  • 7 Dom @moneybeta June 6, 2014, 1:08 pm

    So £50M return x 12 = £600M

    Investment £47000M

    600 / 47000 = 1.27% Is that the 1.3 you mentioned?

    I think you could get into a lot of psychology about lotteries with this stuff, but at the end of the day if you aren’t beating inflation on average surely it’s a bad investment. Unless you have this as an elelment of a mixed portfolio due to the safety reasons (government backed etc).

    I guess it’s the parachute that doesn’t collapse whilst everything else is falling apart during a recession. Although whilst the current good times are rolling why not make hay?

  • 8 CisforV June 6, 2014, 7:18 pm

    I only started investing with a S&S ISA a few years ago, so most of my money is in a cash ISA. It’s mainly my emergency cash fund. However, these days I’d rather not tap into my ISA in an emergency and ultimately plan to move most of the cash into the S&S ISA. But, I still want the safety of an emergency cash fund for peace of mind.

    I rather like the idea of stashing a good few months worth of salary into Premium Bonds to act as my emergency fund. I can top it up to match any salary increases over the years (I can dream) and it won’t impact my ISA allowance. I also won’t pay tax on winnings (again, I can dream).

    Mostly, I like to think of it as my “luck” asset class 😀

  • 9 dawn June 6, 2014, 8:50 pm

    not worth it. i had £30,000 in for years and was getting max £300 a year return.
    when i first bought about 10 years ago i did really well i had £10,000 invested and won £800 one year 8% tax free and then i won £1000 twice but the past few years have been a slow inflation eating painful loss.

  • 10 dawn June 6, 2014, 8:52 pm

    @miss financial freedom. how did you put your picture up in that little box?

  • 11 Greg June 7, 2014, 12:08 am

    @dawn: You need to register your email address(es) with gravatar.com and it will automatically appear on the many websites that support it.

    It’s free. 🙂

  • 12 Sara June 7, 2014, 2:01 pm

    I have a small amount in Premium Bonds. It’s my one and only gamble.
    I used to buy lottery tickets – then realised what a waste of money this was – so I now put that money into Premium Bonds at the beginning of the year – on the basis that I “might” win something and at least I can get it back if I need it (yes I know inflation will make it worth less).
    I don’t do active investing, only passive so it’s a small sum in active gambling!

  • 13 The Accumulator June 7, 2014, 2:41 pm

    I was given £5 as a baby too. Only recently tracked it down after shaking down my mum for every address we ever lived at. With trembling fingers I typed my numbers into the prize finder. Surely after 40-years I was due some luck? Even a tenner would be nice.

    What did I get? Big fat zippity doo-dah.

    Another dream in tatters 😉

  • 14 John C June 7, 2014, 2:58 pm

    “Every month, most Premium Bond winners get nothing.”

    Then they’re not really winners, are they?

  • 15 weenie June 7, 2014, 3:10 pm

    I have about £1k worth of premium bonds which I’ve had for about 10 years. In that time, I’ve won £75. My boss has £600 worth and last year, he won 5 lots of £25! It’s just down to pot luck!

    Like Under The Money Tree, I’ve started buying small amounts of PBs regularly as part of my cash savings although as suggested above, I might start stashing my emergency funds in there too, as it’s simple enough to sell the bonds when you need cash.

  • 16 The Investor June 7, 2014, 3:37 pm

    @UTMT — I appreciate the simplicity of it, but I think mathematically you might be better off trying to keep a full allocation of £40,000 and using some other easy access account for the top-up and withdraw slush fund.

    @bobbyo — Thank you! 🙂

    @Leon — Does it not say somewhere on the winning slip what bond won? Can you work back from there?

    @MissFF — £100 is a very small holding. At current notional rates, you should expect to win *nothing* from that over the next ten years. But I hope you’re pleasantly surprised!

    @Rhino — Yes, Premium Bonds are a prime example of where people are over-weighting their own experiences / those of people near to them.

    @BTS — Can’t beat the clink of pound coins that come with pub quiz prize winnings! 😉

    @Dom — The notional rate is printed by NS&I. (I suspect the £47 billion figure widely cited is rounded to the nearest £1 billion… 😉 )

    @CisforV — Like the idea of a ‘luck’ asset class, but I’d say it should wait until all the other boxes have been ticked for most investors. 🙂 (Particularly as all non-cash investing involves banking on some average-to-good fortune.)

    @Dawn — Sounds like your luck was “mean reverting” to me. 🙂 With respect to the 8% rate, remember that the Bond fund would have been paying a much higher notional interest rate (though not that high) back in the pre-financial crisis era.

    @T.A. — Keep on rebalancing. 😉

    @Sara — Careful, as I allude in the article lottery tickets bought from savings interest might actually be better value. It all depends on your tax status.

    @John C — Oops, fixed now!

    @weenie — Yes, according to Lewis’ calculator (which enables you to backtest your ‘luck’) you have been unlucky. 68% of people with £1000 worth of bonds would have won more than you. In reality you’ve done worse though because the notional interest rate was higher. Hope your luck comes good soon. 🙂

  • 17 Leon @ marginal gains June 7, 2014, 6:59 pm

    @The Investor – I have the bond account number, so I tried to register online today. Two steps in all good, third step = print out a form and return to Glasgow. If that’s not annoying enough “You must sign this form in front of a witness as you are contacting us for the first time”

    I’ll probably get around to doing it, but I’m not sure it will tell me who bought the bond. Thank you whoever you are, long lost relative 🙂 £25 tax free – lovely

  • 18 ADS June 8, 2014, 1:37 pm

    you should do more PG Wodehouse – time for a new tag ?!

    you discount the excitement of getting a few envelopes in the post … and the anticipation that one might be a £1m cheque …

  • 19 Foxy June 25, 2014, 4:56 pm

    Lottery tickets don’t cost £1, they are £2.

  • 20 bob March 31, 2015, 1:42 pm

    Thankyou for this article. Yet another example of how well you write.

    As you say I think they have a place. I’m a top rate tax payer. You fill your S&S ISA, pay off your mortgage, max your pension contribution allowance, contribute to the companies share incentive scheme, put 20k into a Santander account then what? You hold a small amount in non-taxed sheltered sharedealing account to avoid any CGT implications……then? I put the maximum into premium bonds then get 1.41% gross with Virgin Money in a no notice savings account on the rest. Whats left? P2P (sceptical), EIS/VCT (too dumb to understand them and the fees seem high), BTL? (would rather own property trackers)… long story short, I agree they have a place.

    Thanks again for a great site

  • 21 CisforV April 1, 2015, 7:23 am

    Aside from getting married and having children to spread the wealth under their names (obviously not something that happens overnight and there is always the risk of divorce which would not end financially in your favour). If you don’t want BTL, why not move home to a bigger house in a nicer area. No CGT to worry about and you can plough money into paying off a mortgage again. You could also spend the money improving your existing home to increase the value. Then when you’re ready to retire early, downsize and you’ll have some money to play with.

  • 22 The Investor April 1, 2015, 9:36 am

    @Bob — Glad you like the site, cheers! Yes, years of near-zero interest rates is pushing many of us into things we wouldn’t have previously considered. I do dabble a bit in P2p (small amounts) and I’ve also got a growing (but tiny!) portfolio of mini-bonds (never likely to be more than 1-2% of my net worth I stress).

    With the new tax-free savings allowance from 2016 I suppose you might add another Santander-like account to the mix, if you can be bothered with the reshuffling of cash around.

    @CisforV — Worth considering, but a bit depressing from both a personal and a societal perspective. (China’s property bubble is apparently due to them not having many savings options, and I’d have hoped we’d have more choices than they do!) Perhaps a same-sized house in a nicer area is the better choice of the two evils. At least your wear and tear costs won’t rise then.

    A bigger house with an annexe/similar could let you earn about £4K a year tax-free renting out a room, too, though you’ll probably need to be out of the South East for that to be feasible. (Suggesting a top-rate taxpayer let’s out the spare bedroom seems silly, though I do not some wealthy types who rent at the limit to up-and-coming classical musicians, theater folk, and so forth, almost as a form of patronage I think).

    Getting a bit off-topic for this thread though. Maybe worth a new post!

  • 23 Murray Snudge May 6, 2015, 9:17 am

    You guys are getting all tied up with numbers and statistics – you’re taking the FUN out of owning Premium Bonds and the EXCITEMENT of wondering if you will win this month, or next month……..or the month after.
    Do buy Premium Bonds to enjoy them!

  • 24 Minikins May 9, 2015, 4:41 pm

    A few years ago I had a look at recent bigger winners and what sort of holdings they had. I worked out that it was more likely that bonds bought in £5000 blocks would win along with belonging to a higher total bond value holder. No stats to dazzle you as I did it all on an e note with my calculator but I decided it wasn’t worth drip feeding bits of money into them and better to save a lump sum then buy them. I can’t explain what I found but I imagine its a bit like fishing with a net rather than lots of spears! I think they are a fun fantasy but only if you’ve got your ISAs maxed : )

  • 25 Minikins May 9, 2015, 4:50 pm

    Ps love the PG Wodehouse nods, just my cup of tea!

  • 26 Len April 25, 2016, 9:18 am

    I have held the maximum for appx 3yrs I won £500 very early on in my bond days then a £100 along with lots of £25 prizes many months nowt and yet again prizes are being reduced this June, I think I have fared no better or worse than the returns from a bank. I have now cashed them in I am going to find a monthly interest account then put the interest into lucky dip lotto tickets twice a month, more fun than waiting for the 1st, fingers crossed!!!

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