Savers have been left disappointed following news that National Savings & Investment (NS&I) is to cut the interest rates on some of its most popular accounts and reduce the returns payable to holders of Premium Bonds.
NS&I has announced that from 6th June 2016, the chances of winning a prize from Premium Bonds will rise from 1 in 26,000 to 1 in 30,000, with the overall participating prize fund reducing from £67.5 million to £62.9 million.
Although technically prizes, to allow comparison with more traditional savings accounts, the returns from Premium Bonds are often expressed as a percentage return. Following the change, the anticipated effective rate of interest on Premium Bonds will fall from 1.35% per year to 1.25%. All prizes will continue to be tax-free.
Why people invest in Premium Bonds
The bonds are hugely popular for two reasons. First, premium bonds are offered by National Savings & Investments, the government-backed bank. This means your money is completely safe as the bank cannot go bust. Thousands of investors put their money into premium bonds during the global financial crisis as their investments were very volatile and banks were being rescued.
The second reason is the potential to win up to £1m in the monthly prize draws. The bonds pay out around £715 million a year in prizes and this attracts savers.
While the upfront attractions of premium bonds are hard to resist, savers should do their homework. If you look ‘under the bonnet’ the odds of winning are not quite what they seem.
The amount you win ranges from £25 to £1m and the odds of 30,000 to one cover you winning any prize. If you look only at your chances of winning the £1m top prize then the odds are far worse than if you play the National Lottery. The chances of any given bond winning the jackpot are over 1 in 27 billion!
For smaller prizes, too, the odds are not in your favour. Although NS&I pays out prizes that are equivalent to an annual interest rate of 1.25% of the total money held in bonds, the nature of the prize draw means that these returns are not evenly distributed.
Only one person in 20 with £100 invested in Premium Bonds will win any prize in a given year. Even with £1,000 invested, 63% of people won’t win anything, according to moneysavingexpert‘s prize calculator.
To make matters worse premium bonds do not pay any interest on the principal, so the only way your money may grow is through winning ‘prizes’. Unless you have a lot of money invested the chances are that your balance will remain the same.
Even if you invest the maximum amount of £50,000 – with average luck you would expect to win £500 a year – a 1% return. In contrast, if you put that same £50,000 into the best paying easy-access savings account you would earn £725 source: moneyfacts.
So, in purely financial terms premium bonds are a pretty ordinary investment. Unless you beat the odds and scoop a big cash prize you will be worse off than if you stuck with a standard savings account.
At Callisto we feel that 12 months living expenses is usually a sufficient amount of cash to hold on deposit. If your adviser takes the time to understand your needs and goals and invests your capital in line with your ability, willingness and need to take risk then you should invest the rest of your money for the long-term. Keeping costs low and diversification high is the winning formula.