You probably already know the answer to this question but some figures I have seen today from the Motley Fool website make for interesting reading.
Premium Bonds, which are issued by National Savings & Investments (NS&I), cost £1 each. They do not pay any interest. Instead, each eligible bond is entered into a monthly draw for prizes ranging from £25 to £1m. However, the odds of any bond winning a prize are 24,500 to 1. Given the fact that Brits have invested over £84bn in Premium Bonds, those odds do not appear to matter to them.
It is true that the more bonds a person owns, the higher the chance of a prize. Also, the UK Treasury backs any savings and prizes won, so an investor will never get back less than they put in. Additionally, Premium Bond prizes are entirely tax-free. But what kind of returns can an investor in Premium Bonds expect?
Tried and tested
Let’s look at how a £100 per month Premium bond investment, over 25 years, is likely to perform. First, we need probabilities of winning each of the monthly prizes available, and the chance of winning nothing. The required data for calculating these is available on the prize draw details section of the NS&I website.
We will start with 100 bonds that go into the monthly draw. Any prizes won will be used to buy more bonds, and another 100 bonds are purchased each month. There is a limit of 50,000 eligible bonds – anything over this amount is ineligible for the prize draws, and we will do the same in our study.
Ten thousand trials of this experiment are enough to generate some expectations. On average, the wealth level at the end of 25 years was £36,040. 10% of the trials generated a wealth level of £36,625 or higher. 1% of trials resulted in netting £40,950 or more. The truly lucky, the 0.1% club, could expect their investment to grow to £91,825 or more, with one (0.01% of trials) sitting on £1,036,150.
99% of the time, investing £100 per month for 25 years in Premium Bonds will generate £40,950 or less. An investor can do better than this is they find an investment that returns 2.43% each year on average.
Premium returns
The good news is that there are investments out there that have long-term average returns that do indeed beat 2.43%.
EBIP 100, our highest risk portfolio, had an average annual return of 7.74% over the last 25 years, more than 3 x as much; the end value would have been £87,927.49, as evidenced by the chart below.
EBIP 60, our most commonly used portfolio for medium risk investors, had an average annual return of 6.73% over the last 25 years; the end value would have been £75,640, see chart below.
It is important to note that we are not exactly comparing apples with apples here, there are risks with investing in diversified portfolios, you could get back less than you put in, which is of course not the case with Premium Bonds. However, I don’t believe it is controversial to say you are more likely to end up with more wealth if you invest for the long term in a diversified portfolio, compared to investing in Premium Bonds.
The most interesting thing that I take from the chart is the relative lack of volatility of even the highest risk portfolio, brought about by dripping in small amounts regularly and therefore taking advantage of (rather than being disadvantaged by) dips in the markets from time to time.
All of the above having been said, if you are looking for an absolutely safe investment with a miniscule chance of striking it rich, then Premium Bonds might still be for you.
I hope you find this piece interesting but if you have any questions concerning this e-mail or any other finance related matter, please do feel free to contact me at any time.
With kind regards,
Yours sincerely
Graham Ponting CFP Chartered MCSI
Managing Partner
