Are Premium Bonds worth investing in?

The whole concept of Premium Bonds is weird. In terms of branding and psychology though, they’re genius — because everyone seems to know about them, and I’m often asked if they’re worth investing in.

So…are they?

What are Premium Bonds?

When you buy a Premium Bond, you’re lending money to the government. Rather than receiving interest in return (like is the case with normal government bonds, AKA “gilts”), you get entered into a monthly prize draw where you could win anything from £25 to £1 million.

How likely are you to win the £1 million prize? Vanishingly unlikely. How likely are you to win any prize? In any given month, also highly unlikely. Over the long-term though, the size of the prize pool dictates what you could expect to win with average luck. This number is openly published, and at the time of writing the figure is 1%.

So with £1,000 in Premium Bonds, the average person would expect to win £10 per year. However, this doesn’t mean much because (by definition) half of people will be more lucky than that (including a few people lucky enough to win a million) and half will be less lucky. 

Also, because the minimum prize is £25, the return you’ll make is extremely lumpy. You could be lucky enough to win a £25 prize in your first month, which would make you a 2.5% return on your £1,000 immediately. On the other hand, if you won absolutely nothing for three years, you couldn’t feel too hard done by because your luck would only be slightly worse than average.

Basically, the more Premium Bonds you hold and the longer you hold them for, the closer you’d expect your returns to get to the average. Over a short period of time owning relatively few bonds, it’s a total gamble – with a large chance of making next to nothing, some chance of winning something, and a tiny chance of winning big. If you hold the maximum number of Premium Bonds allowed (currently £50,000 per person) for many years, you’ll make around 1% if you’re averagely lucky.

Why buy Premium Bonds?

Being compensated based on a prize draw makes Premium Bonds a pretty bizarre savings product – yet they’re the most popular in the UK, with over 21 million people owning £88 billion of them. Why?

Two reasons:

1: Safety. Premium Bonds are a loan to the UK government – and the UK government defaulting on its debts is possible, but about as unlikely as it gets in the world of investing. I’d consider it slightly less risky than leaving it in a bank account that’s protected by the Financial Services Compensation Scheme (which guarantees savings up to £85,000 in eligible institutions), because in the event of an extreme crisis screwing over bondholders would be an even worse look than reneging on a promise to guarantee bank savings.

2: Fun. I suspect this is the main aspect of Premium Bonds’ appeal for most people. You don’t even notice a few pennies of bank interest every month, but you definitely notice a cheque for £25 dropping through your letterbox when you weren’t expecting one (although the modern equivalent of getting an email saying they’re making a bank transfer is rather less exciting, if more convenient).

Also, because technically the money you make is a prize rather than interest, it’s not taxable – although this will make very little difference on the amounts involved for most people.

So: an odd kind of investment. It sounds like an oxymoron, but you could think of Premium Bonds as a “safe gamble”. Any money you put into them will be just as safe as an insured bank account (if not more so), and you’re gambling as to whether you get some kind of return or none at all.

Who are Premium Bonds suitable for?

I’d consider Premium Bonds to be appropriate for a narrow range of situations:

• Parking an emergency fund. When you make a request to cash in your Premium Bonds, the cash will be returned to your bank account in 3 banking days. This isn’t quite as immediate as cash in the bank…but maybe that’s a good thing, if you’d be tempted to spend it if it’s sitting there.
• Spreading a large amount of cash. The FSCS only protects up to £85,000 per institution, and you have to be careful because some banks with different brands actually share the same allocation (like First Direct and HSBC). So if you’re so loaded you’re struggling to find enough banks to split your cash between, Premium Bonds are another option.
• Making saving up a bit more exciting with the frisson of winning big. With interest rates as low as they are now, it makes basically no difference whether you’re earning a fraction of a percentage point in a bank account or Cash ISA, or potentially nothing in Premium Bonds. The difference is with Premium Bonds you might have above-average luck and get a nice surprise.

What they’re not suitable for is improving your financial future. With average luck, you’ll be losing purchasing power to inflation (boo hiss) every year – and crossing your figures and hoping to hit the £1m prize is not a winning investment strategy.

With the majority of your capital you’ll need to take some type of investment risk and deploy it into stocks, property, a business, or something else with the potential of generating returns that will improve your lifestyle or support you in retirement.

But you always need to keep some amount in cash or an equivalent no- or low-risk investment as an emergency fund (and even holding too much cash isn’t always a bad thing). For that, Premium Bonds aren’t a bad choice.

The way I’d think about it is to assume worse than average luck. Assume you’ll never hit a single £25 or £50, and therefore you’ll receive no interest and forego the fraction of a percent interest you’d get in a bank account (which even on the maximum £50,000 is going to be pretty insignificant). If in that reality you’d be happy just having your money stored somewhere safe, then go for it – and in the unlikely event that you hit one of the bigger prizes, you’ll be very happy indeed.