It’s been nearly 65 years since the government-backed savings provider NS&I launched Premium Bonds to try and get people across the UK saving. And since the launch, the products have become exceptionally popular with estimates suggesting nearly 1 in 3 people in Britain hold Premium Bonds.
However, while the Treasury-backed bonds are virtually risk-free, they don’t offer a regular interest payout. Instead, every month, savers are given a chance to win tax-free prizes ranging from £25 to £1m. As the minimum initial investment for Premium Bonds was cut from £100 to £25 at the beginning of this year, savers could see a quick return on their money. But the reality is the odds of winning a prize are currently 24,500 to one.
Low interest
The closest thing they have to an interest rate is what NS&I calls the annual prize rate, which is currently 1.4%. In theory, this is how much interest every saver will receive on average over the long term. But in practice, the amount actually received will vary greatly and there’s a good chance you’ll never actually win anything from the prize pot.
With this being the case, I’m not a massive fan of Premium Bonds. Indeed, I can think of at least one unrestricted savings account on the market today that offers a higher interest rate with interest paid monthly. I would rather put my money here than take the chances of winning a prize with NS&I.
And if you want to get rich, I recommend investing your money rather than taking your chances here.
A better return
The most common reason why people choose Premium Bonds over other assets, despite their low return, is the fact the Treasury guarantees them. This is a solid argument, but the data also shows that over the long term, the chances of you suffering a total loss from a diversified portfolio of equities is almost non-existent.
Buying an index tracker fund that tracks a global index such as the FTSE 100, would not only give you a higher level of regular income, but it would also provide capital growth. At the time of writing, the FTSE 100 supports an average dividend yield of around 4.5%, more than twice the targeted prize fund return offered by Premium Bonds.
If you’re not comfortable with the volatility that comes with equity investing, bond funds could also be a good alternative. You can achieve a yield of 2-5% from bond funds, according to my research, which is once again significantly higher than the rate of return offered by Premium Bonds.
The benefits of compounding
The impact just a few extra percentage points of return will have on your wealth over the long term cannot be understated. Even if you do win a prize equivalent to the annual prize rate, an investment of £1,000 will grow to be worth £1,149 over a decade. By comparison, the same £1,000 investment in an equity or bond fund that yields an annual return of 5% per annum will grow to be worth £1,629 in the space of 10 years.
I think these numbers illustrate the point clearly. If you want to build wealth over the long term, the best option is to avoid low-yielding Premium Bonds.
