Premium bonds yield less than cash and the returns are set to lag inflation, a multi-manager has warned.
As premium bonds celebrate their sixtieth year, Adrian Lowcock, investment director of Architas, has claimed the product is poor value for today’s investors.
The average yield on premium bonds is calculated by dividing the number of premium bonds in issue by the total winnings available and is currently 1.25 per cent, tax free.
According to Mr Lowcock the best currently available two-year fixed savings account is from Atom Bank paying 1.65 per cent.
He pointed out that is nearly a third more than the average yield on premium bonds.
With the introduction of the personal savings allowance, a basic rate taxpayer would need to put over £60,000 into the account before they earned more than £1,000 of interest and would then have to start paying tax on the income.
Mr Lowcock also warned returns on premium bonds are set to lag inflation.
Currently inflation is 0.6 per cent, according to the Consumer Price Index, but the Bank of England has forecast this is set to increase to 2.4 per cent for 2017 and 2018.
The premium bond prize fund is calculated by HM Treasury and is based on prevailing interest rates.
As such, Mr Lowcock warned the average yield of 1.25 per cent looks set to remain and will drop below the expected rate of inflation over the next two years.
Actual returns lag
Plus, he added, actual returns on premium bonds are less than the average 1.25 per cent yield.
The average yield is the total winnings divided by the number of bonds in issue.
However, the value of the prizes skews the returns.
Each month a bond holder wins £1m. If a bondholder with the maximum £50,000 invested in bonds won the jackpot their yield that year would be 20 per cent.
If you are a winner your average return increases, which means for the majority of premium bond holders the average return falls and is closer to zero.
Chris Daems, director of Cervello Financial Planning, said it is clear that premium bonds represent poor value for individuals holding money in savings and have done so for a decent length of time.
However Mr Daems said he still has clients who like the idea of holding an element of premium bonds in their investment and savings portfolios although average returns are clearly less than what's available from a deposit based alternative.
Architas’ Mr Lowcock said: “Premium bonds do not add up for savers looking for ways to boost their returns.
“The average yield is a misleading figure as returns are skewed towards those who win which means that most investors don’t win anything. Premium bonds are more akin to the lottery than cash savings.”
Jason Hollands, managing director of business development and communications at Tilney BestInvest, agreed but pointed out there were some positives about premium bonds.
He said: “Real returns are non-existent from either cash savings accounts, gilts and premium bonds, though at least with premium bonds you theoretically have a chance of winning a large prize with no risk to capital.
“Certainly the odds of a meaningful win are far better than the Lottery but this isn’t a great place to be tucking long term money away.
“It is also worth pointing out that National Savings & Investments, a government agency, is clearly more credit worthy than a small commercial bank, so you wouldn’t expect it to be paying a higher yield.”
Architas’ Mr Lowcock said premium bonds are still an option for someone who has a large well-diversified portfolio and can afford not to make any money from what they put into premium bonds.
But he added for anyone who needs to grow their wealth premium bonds do not offer good value for money.
Mr Lowcock said: “Cash will at least deliver a return and for those looking to boost that return there other options such as shares, which although riskier should generate a higher income and potential for growth.”
“Savers should be careful when considering premium bonds as an alternative to cash.
“Even in this low interest rate environment cash can beat the average yield on premium bonds.
“The key to savings is being more active with your cash and shop around for a better savings rate as this can significantly boost your returns without changing your risks.”
In defence of the product Jonty Alone, corporate and media relations manager of National Savings & Investments, said 21 million people hold premium bonds, which pay out over two million tax-free prizes each month worth more than £65m.
Mr Alone said: “Customers invest in premium bonds for a number of different reasons.
“Some choose to invest because of the security provided by the HM Treasury 100 per cent guarantee, others like the excitement that they might win a big prize or the enjoyment of receiving regular prizes.
“Parents, grandparents and legal guardians also enjoy being able to purchase premium bonds for their children and grandchildren.”
emma.hughes@ft.com
