Premium Bonds: A View to a Thrill

As a James Bond fan I could not resist creating a pun out of this title and I make no apologies for it (or any other references throughout)!

Whilst premium bonds do not face the same daily life-and-death spectres that make the spy stories so gripping, recent changes to the prizes payouts of premium bonds do raise the eyebrow and makes me pose the ‘Q:’ should they be an investment worthy of consideration?

My personal experience with Premium Bonds comes courtesy of helping my mother move house a few years ago. Mum discovered £10 of premium bonds she had purchased for me at birth (a long time ago). Surely there would be millions waiting for me to collect? Upon checking the prize history, I had the living daylights beaten out of me when, to my horror, they were still worth £10 several decades on! It felt like the sky (was about to) fall and there was no quantum of solace. Shaken, but not stirred, I resisted the urge to sound ungrateful and berate my mother for a poor choice of investment. Instead, I silently plotted what my returns might have been if an alternative investment strategy had been chosen. I arbitrarily chose a S&P 500 Tracker for comparison – a common choice favoured by newspapers. Over the same period, with dividends reinvested, the £10 would now we worth approximately £475, an annualised return of nearly 11%. Granted this is not a like-for-like comparison in terms of risk taken and I am not expecting my mother to have the Midas ‘Goldfinger’ touch when it comes to investments. However, even if we just assumed a rate of return of inflation then the £10 would be worth over £29 today. Ironically, the minimum investment in premium bonds is now £25!

Despite my personal history with premium bonds, I must ignore my biases and look at this investment objectively, rather than be a Dr. No. From 1 September, the average payout from premium bonds will be 4.65% (up from 4%) which is the highest rate we have seen since March 1999; a reflection of increased interest rates. The average payout increase actually manifests itself in the number of prizes increasing, meaning you now have a 1 in 21000 chance to win a prize, down from 1 in 22,000. Compared to the interest rates offered on many bank accounts, premium bonds’ average prize will never offer the highest rate, but this average payout is competitive, particularly given prizes are tax-free, whereas interest is taxable. This is even more relevant given the tax-free savings allowances have been slashed and tax bands frozen, increasing the likelihood that interest earned on cash accounts will be taxable. Cash ISAs do also offer tax free returns, but these accounts tend to offer lower rates of interest than their taxable peers – the top easy access cash ISA I could find at the time of writing was 4.43%, so marginally lower than the average premium bond payout.

However, the key word being used here is ‘average’, mean average to be precise. The two top prizes of £1 million and even the more frequent lower prizes of £100,000, £50,000, and £25,000 skew the averages. In reality, there are a few big winners and many who will receive small payouts or nothing at all. Other than not losing the original investment, this is akin to a ‘thunderball’ lottery. This is in comparison this to interest earned on a bank account, which is guaranteed for a given period.

For a £10 investment (now £25) premium bonds are therefore absolutely a ‘Casino Royale’ investment as the chances of receiving any kind of payout are remote. However, the larger the investment the more likely it is you will achieve returns closer to the average payout – this is simply due to mathematical phenomenon of expectation, i.e. if you make more iterations then you will get to the true probability as variance evens out. When you also consider that Premium Bonds (and other NS&I products) are government backed and that prizes are tax free, it is definitely an investment option for some people to consider. I will continue to hold my £10 – you only live twice after all!