Are Premium Bonds Any Good?

Big news in the Henry household this morning as The Boss has won another £100 on the Premium Bonds. Dinner on her tonight then.¹

Premium Bonds offer a pretty unique option for holding cash. Rather than paying regular interest like a normal cash account, every £1 “invested” into Premium Bonds buys you entry into a monthly draw to win prizes ranging from £25 to £1 million. Which would be nice.

Premium Bonds are offered by the National Savings and Investments (NS&I) in the UK. This means that any money deposited in Premium Bonds, like any NS&I product, is fully backstopped by the Treasury.

NS&I generally offer a great home for clients who are a) more concerned about the safety of their money than getting the absolute best yield; or b) have more in savings than would otherwise be covered by the Financial Services Compensation Scheme.²

Any money that you win on the Premium Bonds is not taxed, which again is a point of difference versus a regular cash account. So for higher and additional rate taxpayers in particular, who would pay 40% or 45% on any interest on their savings (above any savings allowance they might have) Premium Bonds are particularly attractive.

The major advantage of course is that you could win one of the big prizes, which in terms of return, blows every other cash account out of the water.

This all sounds amazing. What’s the catch?

If you don’t win any prizes, you don’t get any interest, so you get nothing.

At present, easy access cash rates of 4-5% are available from proper banks and these numbers are higher than the current rate of inflation in the UK (which is officially running at between 1.7%-3.1% depending on your measure of choice). So the opportunity cost of holding Premium Bonds, if you don’t win anything, could be quite high even compared to a normal cash account.

The average return on Premium Bonds is 4.4% at the moment - which is pretty attractive for a fully government backed savings product. But this average is highly skewed by the big winners. The median investor does far worse than that.

If you were to line up everyone with £1,000 worth of Premium Bonds in order of their winnings this year, the person halfway along the line wouldn’t have won anything.³

Like any lottery, the more tickets that you buy the more likely that you are to win. So those with more invested in Premium Bonds are likelier to win something which might seem blindingly obvious, and maybe not all that fair, but that’s life. Money flows to money.

So, should I buy Premium Bonds or what?

In my opinion, Premium Bonds aren’t a great option for most people. The returns are just too narrowly spread around.

Your cash savings are there to provide your financial bulletproof vest, they aren’t there to generate a massive return - the money just needs to be safe and it needs to be there. But if you can get a decent return, over and above inflation, from a conventional savings account at the moment it seems silly to turn that down.

However, for those with a cash allocation in the hundreds of thousands - a £50,000 allocation to Premium Bonds (the maximum available per person) can offer a tax efficient means of (potentially significantly) juicing the return that they are getting on cash while reducing their “counterparty risk”.⁴

Have a great weekend.

1. Wishful thinking.

2. The Financial Services Compensation Scheme offers government backed coverage to a range of savings and investment products.

When it comes to savings accounts, cover is limited to £85,000 per person per institution. So if I, for example, have £150,000 on deposit with HSBC and they were to go belly up - I would only be able to claim £85,000 under the FSCS.

Now, the experience of the Financial Crisis and the Silicon Valley Bank debacle last year (remember that?) would suggest that governments will, when push comes to shove, stand behind large systemically important banks in a crisis. But this isn’t guaranteed.

3. Source: MoneySavingExpert

4. The risk that a commercial bank goes under.