Why Premium Bonds Don’t Make Good Savings Accounts

by Jane Baker on 23 December 2008  |  13 comments
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You might buy premium bonds for the chance of winning the £1 million jackpot, but they’re no good for your savings.

23 million people have taken out premium bonds worth a whopping £26 billion. But why are they so staggeringly popular? Could it be the chance of winning the fabulous £1 million jackpot?!

How do premiums bonds work?

You can invest between £100 (or £50 if you save monthly) and £30,000. Each £1 you invest will be allocated one bond number. There’s a prize draw each month, and if one -- or more -- of your numbers are drawn you’ll win a tax-free prize of at least £50. On current odds there are over one million cash prizes on offer. And each £1 bond number has an equal chance of winning a prize.

If you’re really, really lucky you could win the top prize -- the £1 million jackpot! What’s more, there are two chances to win the jackpot every month.

So instead of earning interest on your premium bond savings, you’ll have the chance to win tax-free prizes. So the more bonds you have, the better your chances of winning.

But are premiums bonds worth it?

Unfortunately as a serious way of saving, I think premium bonds fall seriously short of the mark. And -- even worse for those 23 million savers --they have just become even less attractive.

Like virtually all savings accounts, premium bonds have suffered following the recent dramatic cuts in the Bank of England base rate. The premium bond prize fund rate -- which is the amount paid out in prizes as a proportion of the total amount invested -- has dropped off from 2.85% to a measly 1.8% a year. That’s even lower than today’s tiny 2% base rate, and it’s unlikely to beat inflation over the long term.

As the prize fund rate has fallen so too have the chances of winning some cash. The odds of winning a prize with each £1 bond have risen from 24,000 to 1 to a whopping 36,000 to 1.

So if you invest the full £30,000 -- with ‘average’ luck -- you could now win ten prizes a year, instead of the 15 prizes that could have been won at better odds of 24,000 to 1. If you won say, £50 each time, your total for the year would be £500. But that’s not a great return on savings of £30,000. And there are no guarantees you’ll win any prizes at all.

Each month’s prize fund is equal to one month’s interest on the total value of all bonds. But because the rate has fallen to just 1.8% a year, the total prize fund is now smaller and so the chances of winning are lower. Let’s take a look at how the prize draw is shaping up for next month so far:

Estimate for January 2009 prize draw

As you can see there are still over one million prizes up for grabs and an estimated total prize fund of £57 million to be paid out. But there might only be 23 higher value prizes of £5,000 or more on offer.

Why would you buy premium bonds?

As a way of earning a decent return on your savings, premium bonds don’t fit the bill. But since rates on many savings account are pretty dismal, you might be tempted to try your luck.

If nothing else you’ll have the peace of mind that comes with investing in a National Savings & Investments (NS&I) product such as a premium bond. NS&I is backed by the Treasury so while you may not earn much of a return, your capital will at least be secure. In the current climate, a safe haven for your savings may be your top priority.

At best I think premium bonds could be a good alternative to the National Lottery for a smallish pot of savings. Playing the lottery means losing your stake if you don’t win, but you don’t need to worry about that if you buy premium bonds. And you never know you could even win the jackpot one day!

More: Earn 6%+ On Your Savings | Compare savings accounts at The Fool