Premium Bonds

Just fun. Sometimes a good bet, rarely a good investment.

Brief Facts

Premium bonds are issued by ‘National Savings and Investments’ (NS&I).  They are backed by the HM Treasury. This page written in 2020. Current information here.

The maximum investment per person is £50,000. Prizes are paid on randomly selected bonds each month for as long as the bonds remain invested.   A 'Prize Fund Rate' is published to determine the amount of prize money to be distributed. It is equivalent to the interest rate that would apply to a normal instant access account.

Bonds can be redeemed at any time and your initial investment returned.  It is quite easy to get your money in and out.

Prizes are tax free.

Prizes

The amount paid out in prizes is calculated precisely based on the 'Prize Fund Rate (PFR)'. The prize fund each month is one twelfth of this rate multiplied by the total number of premium bonds in the draw. For the December 2020 draw the PFR was 1%.  NS&I can change this rate at any time, and will do so to relate to changes in rates on cash (for example the PFR at September 2023 was 4.65%).

The distribution of prize money (at December 2020) was:-

1.00% is equivalent to 1.25% gross for a standard rate (20%) taxpayer, 1.67% for a higher rate (40%) taxpayer and 1.82% for an additional rate (45%) taxpayer. These are pretty good rates compared to normal deposit account rates now plunging towards zero (2020), always remembering that a slice of your return has been gambled against a possibility of big prizes - lottery style. But......

There's one reason for buying that is usually considered too shameful to mention:-

It's fun for some!

It's a gamble! If you buy a thousand bonds then, on average, you'll win a prize every three years and  a major prize (£5,000 and up) every 42,717 years and your annual cost in loss of income will be a few pounds. If that turns you on, good luck!

But here is some irrational behaviour you should watch for. If you find yourself doing it, ask yourself if it's appropriate in the serious business of investment.

The experience illusion (1)

People buy more bonds if they have won a few prizes - thinking they are on a hot streak.

But only the published interest rate affects their future prospects. 'The computer doesn't remember'.

The experience illusion (2)

People keep records of their win percentage. They buy more bonds if it's good. See above.

"It's my turn"

People buy more bonds if they haven't won for a while. See above.

"My numbers are bad"

People will 'change their numbers' - sell and repurchase - if they don't win. This is particularly stupid because they may miss a draw.

Our view

If you like the idea of gambling with some of the interest that you would otherwise receive from an instant access account, then this may be for you. In fact if you are a higher rate tax payer, and the PFR is high, it might be a good deal for you. But:-

• the prize fund rate won't always be as good (relative to cash) as it is now, 
• you'll have to watch the changes in the prize fund rate relative to the instant access rate to manage your money properly, and
• you'll need to buy a lot to get any sort of buzz (unless £25 in the mail once every three years on an investment of £1000 turns you on).

They can only ever be a niche part of a serious savings plan.