With interest rates low and investment markets experiencing volatility throughout 2020, you may be looking for an alternative place to put your money. Premium Bonds are an option you may be considering, but you could end up missing out on returns.
What are Premium Bonds?
Premium Bonds are a type of investment product issued by National Savings & Investment (NS&I), but they work differently to other types of investments for two key reasons:
- The money you place in Premium Bonds is safe and fully backed by the government. This means when you want to withdraw your money, you’ll receive the same amount you deposited.
- Rather than receiving interest or investment returns on your money, you’ll be entered into a monthly prize draw. Prizes range from £25 to £1 million. The more bonds you purchase, the more times you’re entered. Prizes won are free from Income Tax and Capital Gains Tax.
As a result, if you’re lucky, your Premium Bonds could earn you far more than a savings account or investments if you won one of the larger prizes. However, there’s a real chance you’ll receive nothing at all.
One of the reasons that Premium Bonds are attractive is that your deposits are secure. When you decide to withdraw your money, you’ll receive the same amount you put it, but once you factor in inflation, your savings will be lower in value in real terms. This is because the cost of living rises each year and, unless your saving increase by the same amount, your money buys less. In the short term, this effect is minimal. However, look at the impact of long-term inflation and it can be significant.
To keep pace with inflation, your Premium Bonds would consistently need to win the prize draw. So, how likely is that?
According to Money Saving Expert, if you placed £5,000 in Premium Bonds and had average luck, you’d expect to win roughly £50 a year. Of course, there are thousands of people with Premium Bonds that have below-average luck and are potentially missing out on returns.
Recent change means 1 million fewer Premium Bond prizes every month
Since their introduction, Premium Bonds have been popular products. In fact, over 21 million people hold Premium Bonds and over £80 billion is placed in them. But changes in November 2020 mean they’re not as attractive as they once were.
Previously, the prize rate for Premium Bonds was 1.4%, this means each £1 bond had a one in 24,500 chance of winning a prize. The change meant the prize rate was slashed to 1%, resulting in odds of one in 34,500 per bond. That means over one million fewer prizes are given out each month.
As a result, there’s now a greater chance that your Premium Bonds will earn nothing at all, and inflation will affect the value of your savings.
With this in mind, should you use Premium Bonds?
As with every financial decision, the answer will depend on your goals and situation. If you’re looking to create a regular income or guaranteed returns, Premium Bonds are not likely to be the right product for you. However, if you’ve made use if other tax-efficient allowances, such as the Personal Savings Allowance and ISA allowance, they can be a useful option to consider.
How do Premium Bonds compare to savings or investments?
Before you decide if Premium Bonds are the right option, you should weigh up the alternatives too.
Savings: If the security of your money is important, a traditional savings account may be the right option. Assuming you stay within the limits of the Financial Services Compensation Scheme, your money is safe. It will earn regular, guaranteed interest. However, interest rates are low and can mean your savings don’t keep pace with inflation. If you’re in a position to do so, choosing products with restrictions, such as locking your money away for a defined period, can help you access higher rates of interest. Saving accounts are a good option for emergency funds and short-term saving goals.
Investing: If it’s the potentially higher returns that are attracting you to Premium Bonds, investing may be an option. Money invested can deliver returns higher than interest rates, but this is not guaranteed, and your money will be exposed to investment risk. This means that your initial investment can fall, as well as rise, in value. Over the long term, investments have historically delivered returns, so a minimum timeframe of five years is advisable when investing. If you’re focused on long-term returns, investing could provide an alternative to Premium Bonds.
Finding a home for your savings
There’s no right or wrong answer when deciding where to put your money, but it’s essential that you consider what you want to get out of it and your financial circumstances. Please get in touch to create a financial plan that considers your options, whether you have a lump sum to save or want to make regular deposits.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
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