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.”
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|
|Medium value (4% of prize fund)||£1,000||811|
|Lower value (91% of prize fund)||£100||12,238|
|Totals for February 2014||£50,765,275||1,802,318|
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!