Why premium bonds are poor value

Why premium bonds are poor value

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.  

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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.