Analysing the Pros and Cons of Premium Bonds

Analysing the Pros and Cons of Premium Bonds

In recent months, there’s been renewed interest in Premium Bonds, with a number of people asking us whether they’re an effective strategy for saving money. As interest rates on conventional savings accounts remain relatively low, the desire to look elsewhere is understandable. But, it’s important to understand exactly what Premium Bonds are and how they work, as they’re different to traditional savings accounts in a range of ways.

So, in this article we’re going to give you a bit of an introduction to how Premium Bonds work, as well as some insight into the pros and cons of this form of investing.

What are Premium Bonds?

Premium Bonds are a kind of savings account, run by NS&I. When you buy a Premium Bond, you effectively agree to not receive any interest on the money you put in the account. Instead, NS&I run a monthly prize draw, where each bond has an equal chance of winning.

One cool thing you might not know about is the random number machines that are used to draw the winning numbers in the Premium Bond lottery. Known as ERNIE (Electronic Random Number Indicator Equipment), there have been 5 of these machines so far. The original machine used the same technology as the Second World War codebreakers at Bletchley Park, while the current equipment, ERNIE 5, uses quantum technology!

Because each bond has an equal chance of winning, we can calculate the average winnings a bond should earn over a period of time. This would then be roughly equivalent to the expected interest rate. However, this is only the average winnings – meaning some people will earn more and others a lot less.

What are the pros of Premium Bonds?

So, what makes Premium Bonds so attractive to people? Well, there are a few key reasons why they’re generally considered a good place to hold your emergency fund

Lots of prizes drawn every month in the lottery

Because Premium Bonds essentially operate a monthly lottery prize draw, you’ll always in with a chance of winning big money – it can be up to a million pounds! For a lot of people, being “in it to win it” is a big selling point of Premium Bonds.

And, even if you don’t hit the jackpot, there’s still plenty of smaller prizes drawn every month.

Your money is safe (and you can access it)

Unlike other kinds of investments, you can’t lose your money with Premium Bonds. Even if you don’t win the lottery, your original investment won’t go down – so there’s a lot of potential reward with no investment risk.

Premium Bonds also give you access to your cash, so if you need it, you can get your money back out quickly. For people who have money to invest but aren’t sure when they might need some of it back, this is a big plus.

It’s tax free

One big advantage of Premium Bonds is that the prizes you win are tax-free. This essentially means Premium Bonds offer tax-free interest on savings! While many people don’t pay tax on their savings interest, if you do then Premium Bonds are a very attractive option.

What are the cons of Premium Bonds?

On the other side of the Premium Bonds question, however, we have the issue of luck. As the effective interest rate you’ll get on Premium Bonds depends on the luck of the draw in the lottery, it’s possible that you’ll essentially be receiving no interest on your money.

This all comes down to statistics. The prize draw on Premium Bonds is 1%, but what this actually means is that a person with average luck will get about 1% of their money back in prizes as interest. Of course, you could win a lot more than 1%. But for every person who does win more, there’ll also be a person that wins less.

As with any lottery, then, how much money you’ll get back on Premium Bonds depends on how lucky you are.

The other thing to bear in mind is inflation. As there is no growth on the money you pay into premium bonds, the capital can be eroded by inflation.

For more insights and analyses into a range of financial topics, follow the Face to Face Finance blog and sign up for our monthly newsletter.

This article is informational and for entertainment purposes only. It should not be considered as investment advice. Your capital is at risk when you invest.

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