Why Premium Bonds are a rubbish investment

by Harvey Jones on 05 March 2012  |  32 comments
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A third of us have money stashed away in Premium Bonds. But is there not a better home for our cash?

Everybody loves Ernie. He’s a national treasure. I remember him from my childhood, big-heartedly dishing out random cash prizes every month. Premium Bonds were a big thing when I was a boy, and they’re even bigger today.

An incredible 22 million people hold them. That’s one in three of us. They really are the nation’s favourite investment. This is why I feel bad for pointing out that they are a bit rubbish these days.

A nice little Ernie?

I know, this is a bit like criticising your best uncle because he didn’t give you an expensive birthday present, but it has to be done. Lovable old Ernie (which stands for Electronic Random Number Indicator Equipment, which is used to pick the winning numbers), with his folksy name and government-backed reliability, is looking a bit stingy these days. And because one in three of us are emotionally and financially attached to him, I thought you should know.

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This is a pity, because in today’s uncertain times, a solid chap like Ernie should be in his prime. Instead, he is repaying loyal savers with an average prize fund interest rate of just 1.5%. That looks pretty miserly to me.

Prize downsize

There’s no denying Premium Bonds have pedigree. They were launched in 1957, when Harold Macmillan was Chancellor, Britons had never had it so good, and the top prize was £1,000 (£17,000 in today’s money). That was enough to buy you a brand-new Morris Minor at the time.

Ernie has moved with the times, upping the jackpot to £1 million in 1994. Even the National Lottery couldn’t bury him.

He is still dishing out the dosh. In July 2011, Ernie paid out more than £53 million. As well as that £1 million big one, he handed out four prizes of £100,000 and nine prizes of £50,000.

If you hold Premium Bonds, you are likely to have won more than once, but you probably won’t be rich. Nine out of 10 prizes are for £100 or less. Most people pocket £25.

Stingy old Ernie

You can dream of winning a million, but the chances are low. The odds depend on how many bonds you hold. Each bond costs £1, although the minimum stake is £100

If you hold the minimum £100 of bonds, your chances of a million are a massive 150 million-to-one. By comparison, your £1 Lottery ticket gives you a 14 million-to-one chance of becoming a millionaire.

If you hold £1,000 worth of bonds, your odds fall to 15 million-to-one. But even if you hold the maximum £30,000, your odds are still 500,000-to-one.

True, your bonds go back into the draw every month, whereas a losing Lottery ticket is just litter. But your average return is likely to be 1.5% and that ain’t great, especially when you can Earn 6% a year on safe investments.

A less than premium bond

In defence of Ernie, that 1.5% average interest rate is free of tax. So if you are a 40% taxpayer, it is worth 2.5%. And 3% to a 50% taxpayer. But many Premium Bond holders will pay basic rate tax, or no tax at all, which means they are getting a raw deal.

And to be fair, that tax-free return of 1.5% is double the average savings account, which pays a taxable 0.7% or so. If you’re a lazy saver, who can’t be bothered switching their money around every year or two to secure the best rate, you could do worse than Premium Bonds.

But the prize rate is still disappointing. It isn’t even good by the standards of National Savings & Investments, the government-backed body that runs Premium Bonds and other savings plans.

Its Direct ISA pays a variable 2.5% - an astonishing 60% more - and is also tax free.

Ernie is beginning to take his loyal savers for granted. It is about time he was told.

If you need a regular income from your savings, don’t turn to Ernie. Your winnings are likely to be sporadic, and there may be periods when you win nothing at all.

Naughty old Ernie

By all means have a flutter on Premium Bonds. He’s still good for a giggle, cheeky old Ernie. But use your cash ISA allowance first for a reliable return. You can compare the latest cash ISA rates in our ISA comparison centre.

Premium Bonds work best for savers in higher tax bands, who already have a spread of savings and investments for regular income and growth, and want a little bit of excitement on the side.

The sad truth is that Ernie has lost the common touch. These days, he’s a rich man’s plaything. Who knew?

This is a classic lovemoney article that has been updated

More: Over £40m Premium Bond prizes unclaimed | Latest Premium Bonds winners