Are Premium Bonds a good investment?

Premium Bonds are a type of savings account. Rather than earning interest each month, your savings are entered into a prize draw, from which one or two lucky savers earn £1million.

But are Premium Bonds a good investment? To figure that out, you need to understand how they work.

How do Premium Bonds work?

For every pound you invest in Premium Bonds, you get one entry into the prize draw. Prizes range from £1m to £25.

Prizes are drawn once per month. All Premium Bond prizes are tax-free. This means you don’t pay Income Tax or Capital Gains Tax on your winnings.

Buying Premium Bonds

You can only buy Premium Bonds through NS&I.

You can apply for Premium Bonds online, by post or over the phone.

Once you’ve bought your Premium Bonds, it takes one month to be entered into the prize draw.

The minimum investment is £100, unless you pay by bank transfer, in which case the minimum is £50.

The maximum investment is £50,000.

The more you invest, the more chance you have of winning.

Chances of winning Premium Bonds

Premium Bonds are heavily weighted towards those with the biggest investments. This is because each pound you invest gets you one entry into the prize draw.

There are around 21m people who hold Premium Bonds, with a total of almost £72bn invested.

This means the odds of winning even the smallest prizes are low.

If you have £100 worth of bonds, the odds of you winning £25 – the smallest available prize – is 2,450 to 1. The odds of winning £1m is around 3 billion to 1.

It’s more likely that you’ll win nothing.

With a £50,000 investment – the maximum allowed – you’re virtually guaranteed to win something over the course of a year.

But this doesn’t necessarily mean it’s a good return on your investment.

Let’s say you’ve invested £50,000, and you win £500 in prizes over the course of a year. This is a 1% return, which is lower than most savings accounts.

Premium bonds average return

NS&I’s website lists an “annual prize fund interest rate” of 1.4%. But this isn’t a guaranteed return on your investment. It means that, when all the prizes given out to all the investors are averaged out, the average pay-out in prizes per person is equal to a 1.4% interest rate.

But this number isn’t meaningful, because the majority of people won’t win anything.

Finding the “average return” depends what kind of average you use. The median average, which is the most useful way to measure the chance of winning Premium Bonds, is £0.

To virtually guarantee at least one prize over the course of a year, you need to invest around £10,000.

Advantages and disadvantages of Premium Bonds

Are Premium Bonds a good investment? It depends what kind of investor you are, how much money you have to invest, and what your priorities are.

Advantages

The main advantage is obvious: there’s always a chance, however small, that you’ll win big. If you do, the returns will likely outperform any savings account on the market. But the odds are long, especially if you only have a small amount of money to invest.

The other advantage is often overlooked: it’s fun. Checking your account each month to see if you’ve won is more exciting than a normal savings bond.

Anything you do win is tax-free, too. But, with the introduction of the Personal Savings Allowance in 2016, 95% of people in the UK don’t pay tax on their savings interest anyway.

Disadvantages

Premium Bonds don’t earn interest, so if you don’t win you gain nothing on your savings.

Because of inflation, this would mean you’re effectively losing money. Your savings will be worth less in real terms than they were when you invested them.

Premium Bonds are also heavily weighted towards people with larger investments. If you have less than £1,000 to invest, it’s very unlikely you’ll win anything.

Alternatives to premium bonds

If you’re willing to take a risk to get more from your savings, there are alternatives to Premium Bonds.

Family Building Society’s Windfall Bond

Family Building Society offers Windfall Bonds. Unlike Premium Bonds, Windfall Bonds earn interest every month. The interest rate is equal to the Bank of England Base Rate.

Each month, all Windfall Bond account holders are placed in a prize draw. You get one entry per bond.

The potential prizes are smaller, but the odds of winning are much higher. Family Building Society’s website says that an account holder with one bond has a 64/1 chance of winning in the first 12 months.

The Windfall Bond is less suited to people with small amounts to invest, because each bond costs £10,000.

Halifax savers prize

Each month, registered Halifax savers are entered into a prize draw. Unlike Premium Bonds and the Windfall Bond, each customer gets just one entry.

To be eligible, you have to be at least 18 and have a Halifax or Royal Bank of Scotland savings account with £5,000 in it.

Investment apps

More and more financial risk-takers are using investment apps for the chance to get a bigger return on their savings.

Historically, investing was only suitable for people with lots of money to invest, but this is no longer the case. “ Robo-advisers” make it possible for anyone to get started with a tailored investment plan.

There’s always a risk that you’ll lose money, the potential gains are much higher than you’d get with a high street savings account.

Many investment apps let you get started with just £1, such as Moneyfarm, Wealthify and Wealthsimple.

Some investment apps don’t need any up-front investment at all. Moneybox, for example, helps you invest by rounding up your card purchases to the nearest pound and putting the change in a Stocks and Shares ISA.

If you’ve ever bought Premium Bonds, share your feedback by leaving a review.