Premium bonuses: advantages and disadvantages

In May of last year, I invested £ 1000 in premium bonds. So far, I haven’t won anything and I still have my £ 1000 in bonus. My plan was to keep them for 12 months before re-evaluating whether or not I should keep them. This article will discuss the advantages and disadvantages of premium bonds as an investment vehicle and conclude with my decision.

How they work

Basically, the monthly interest earned on each Premimum Bonus is pooled to form the prize fund. Then, a prize draw is conducted using a computer (ERNIE), which randomly selects the winners.

The details

To be eligible to buy Premium Bonuses, you must be at least 16 years old and you must invest at least £ 100 (or £ 50 via standing order). Premium vouchers can be purchased as a gift for a child under the age of 16 by their parents and grandparents. The most that can be invested in premium bonds is £ 30,000.

Premium Bonds are provided by National Savings & Investments, which are backed by HM Treasury, so your capital is extremely safe.

The numbers

According to the National Savings & Investments website, there are currently £ 26 billion value of the bonds issued. The interest rate used in calculating the award fund is 3.60% (since February 2007), there are 1,417,836 prizes each month and the total value of the prize fund £ 102.1 million.

The prizes are tax-free and range from £ 50 to £ 1,000,000.

Chance of winning

National Savings & Investments declares that the chance of winning (any) prize is one in 24,000 by voucher. Using the other figures on their website (1’417’836 prizes and 26 billion bonuses), I estimate that there is a one in 18’338 chance of winning something per bonus, although it’s worth noting that these figures may be out of date. Obviously, they cannot update the figure every time a bond is sold 🙂

It’s also worth noting that if you win, you only have a one in 708’918 chance of winning a million, making the odds of hitting the jackpot one in 17 billion.

How does it compare to the national lottery?

The National Lottery (or Lottery, as it is now called) gives each ticket a one in 14 million chance of winning the jackpot, which is usually at least one million. This compares with a probability of one in 17 billion with premium bonuses. There is a one in 54 chance of winning a prize with Lotto, compared to a one in 24 chance of winning a prize with premium bonuses. However, with premium bonuses, you retain your capital of £ 1 per bonus and can be used in multiple draws. With Lotto, every £ 1 spent on a ticket is lost and the smaller prizes are lower than the premium bonuses (£ 10).

Advantages Disadvantages

In summary, below are the advantages and disadvantages of investing in Premium Bonds:

Advantage:

• Ability to earn more than you have earned in interest
• Exciting investment
• The prizes are tax free
• Capital is retained
• Capital is safe (backed by HM Treasury)

Disadvantages:

• Poor interest rate / prize fund
• Little chance

My decision

My personal opinion is that having analyzed the numbers in depth, the cons far outweigh the pros, so I will cash them after the June 2007 draw takes place. This is because the June drawing offers 5 prizes of £ 1 million instead of the usual 2. I can keep a minimum amount (£ 100) for the fun look. I will use the money to meet one of my goals for 2007: invest £ 1000 in something that produces more than the best savings account.