Are Premium Bonds Worth Investing In: the Pros & Cons

During one of my recent Ask Me Anything sessions in my Money Circle membership, one of my members was asking about premium bonds. I decided having conducted some up to date research that my findings around are premium bonds worth investing in would be well worth sharing with all of you.

What are premium bonds?

Premium bonds were launched back in 1994. They are bonds that you purchase in exchange for a chance to win of many prizes. There are 2 millionaire winners every month. There is a monthly prize draw, with the minimum you can hold in bonds being £25 and the maximum being £50,000. Winners are selected by a machine called Ernie – incidentally there’s a really interesting story about how Ernie was invented back in 1956 by a code breaker at Bletchley Park. Bletchley Park is a fascinating and really educational visit if you haven’t been before.

Both Harold Wilson and Church leaders warned the population against premium bonds; Harold Wilson called it a “squalid raffle” and the church concerned that it would lead the population into gambling. What’s interesting to me about that is the psychology behind the opportunity to win. A very common behavioural bias that we face as human beings is one of loss aversion. We feel the effects of a loss twice as much as we feel the effects of a win, therefore we are more likely to avoid anything where there is a perceived potential to lose. But where there is a perceived chance to win, we can also be drawn to this.

Are Premium Bonds worth it?

The average return based on average winnings is equivalent to a return of around 1.4% interest, but there has been an announcement recently that they will be cutting this to 1.3%, and this would obviously affect your chances of winning.

If you’re reading this at the time of posting it, March 2020, we’re going through a pretty severe global stock market crisis as a result of the Covid-19 virus. So there is definitely some concern in the market about certainty of returns and where you should be holding your money, and where is safe to hold your money. I won’t go into the stock market right now in detail, but what I will say is that when you’re considering whether to invest what you need to think about is not when the right time is to invest, but how long you will be investing for and what the purpose is for investing.

If you’re investing, for example, for your children’s university fees which is a long term investment, then premium bonds are just not going to grow that well. We have something called inflation risk, which put very simply is about inflation and the day to day cost of things increasing. The current rate of inflation in the UK is around 2-2.5%, so if you’re keeping money in premium bonds for the long term, then actually at 1.4% return your money will be reducing in terms of its buying power.

Although there’s no capital risk – the money you have in premium bonds will always be there – there is an inflation risk. I like to think about making decisions around where to store your money as being a bit like your food shopping:

Your fridge – things that you want to be using or accessing frequently. These are things like your everyday bank account and your emergency fund. You understand that by keeping it in the fridge, you’re not going to get the best return, but that’s okay because you have plans for using or spending it in the short term.
Your store cupboard – these are things that you may need to access, but less frequently. So it could be things like your regular savings accounts, 12 month fixed rate savings accounts. Accounts where you’ll see a little more interest, and won’t necessarily have immediate access.
Your freezer – these are your long term growth pots. These are the accounts that you can get away with forgetting about. If you have money that you know you don’t need to instant access to and you can get away with forgetting about, then this is where you can consider putting it in these accounts. And it doesn’t matter if the value of this money goes up and down, because you have your fridge and store cupboards stocked up.

When you think about it like this – do I need instant access to this, some access, or no access – can really help you to make difficult financial decisions on where to put your money.

Obviously these days, we’re often able to access our investments very easily, but really you don’t want to be doing that. As we are seeing right now the markets do go up and they do go down, so any money that you have invested really needs to be money that you have the confidence in being able to leave for quite some time. Timing in the market is way more important than timing of the market.

If you’ve got money sitting in premium bonds that you currently don’t have any plans for within the next 10 years or so, then I would be questioning leaving it in an account where potentially that’s going to give you a 1.4% or 1.3% return from May 2020. There are opportunities to be making better returns, albeit with some degree of uncertainty.

But couldn’t I win big with premium bonds?

The odds of winning big with premium bonds are very, very small. The chances of winning the National Lottery are actually greater than the chances of winning big on premium bonds. The odds are 1 in 34 billion of winning the top prize according to Which, and depending on where you read the stats on this, the odds of winning the lottery is more like 1 in 45 million.

I don’t know about you, and this will come down to your behavioural biases, but I would far rather have a more certain guarantee on my savings returns, and for any money that I’m not wanting a guarantee because I want the potential for greater growth, then I would be looking at investing in the stock market.

Are premium bonds safe?

One of the reasons that people used to keep their money in premium bonds was that they felt their money was safe. A financial change that was introduced fairly recently was the financial services compensation scheme. This means that you are entitled to your money back under the compensation scheme up to a value of £85,000, per person, per institution should anything happen.

So for example, if you’re looking at rates right now, Marcus bank is one of the top paying interest accounts right now VS premium bonds. Maybe you haven’t heard of them; they’re part of Goldman Sachs. Maybe you haven’t heard of them either, so you start to think no, I feel safer with my premium bonds. I know who NS&I are and all about them. But under the compensation rules, Marcus bank are covered by this meaning if they were to go completely bust your money would be protected up to £85,000 and you would get that money back within 7 days.

Think about that when you’re thinking about where to put your money. Make sure that the institution you want to use is a regulated institution. There are some handy tools on The Money Saving Expert website where you can check if institutions are regulated and therefore part of the financial compensation scheme. Another thing that I always suggest is just to check the footer of their website for the fscs logo, which will tell you that they are regulated and therefore part of the scheme.

What if I have existing premium bonds?

If you’ve ever moved house, you’ll know that we often forget to update our addresses with various companies. Pensions and national savings often seem to be missed! So if you have existing premium bonds and you’re wondering if you have any unclaimed prizes, you can change your address directly with NS&I and there’s actually an app called the Prize Checker app (android link here). There’s no time limit on claiming these prizes too, so you can check these anytime.

The personal savings allowance

This is one of the things that I believe makes premium bonds less attractive than they used to be. The personal saving allowance was introduced in April 2016, and essentially means that most people will no longer pay tax on their savings. This is in addition to your income tax allowances. For a basic rate tax payer, this means you can earn £1000 of interest on savings without paying tax on that, and if you’re a higher rate tax payer it’s £500.

If you had £100,000 in a savings account right now paying, let’s say, 1% interest, then you’re going to hit that limit. So unless you have a very substantial amount of cash like that, then you’re not going to hit that £1000 threshold. What that means is that previously where we all used to put our money into ISA’s, if you can get a better rate by keeping it in a higher rate savings account, then it may be worth you doing that.

Whenever I work with people, I always think about a few things. What rate taxpayer are you, are you using your personal savings allowance, are you using your ISA allowance, and what is the purpose of the money that you are saving? So think about this when you’re shopping around for your saving rates. Unless you’re earning more than £500 as a higher rate taxpayer or £1000 as a lower rate taxpayer, then that actually means you can still have a substantial amount of money in a regular savings account and earn that interest without having to pay any tax on it.

In terms of alternatives to premium bonds, with a higher rate savings account you’ll know exactly what return you’re going to make which gives you more certainty than premium bonds. Your money will be protected up to £85,000 under the compensation scheme, so you don’t have to worry about that. You’ll also have the flexibility of accessing that money when you need to.