The new HFP chat thread – Monday 8th June

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• Roy says:

  8 Jun8 June 23:40

  There was some discussion on Premium Bond interest rates a couple of days back. t wanted to w.rite something back then but didn’t have time. So here it is: these are my thoughts on premium bonds

  Forget the 1.4% headline interest rate. What you’re interested in is the fact that each £1 bond gives you a 1 in 24,500 chance of winning a prize. The smallest prize is £25, and in fact the vast majority of prizes awarded are £25 prizes. Just ignore the bigger prizes.

  Each £1 bond has a 1 in 24,500 chance of winning a prize. This means, if you invest £24,500 in Premium Bonds, then you will win, on average, one prize a month. Of course, some months you will win no prizes, and some you will win two prizes (or even three). But,, on average, you will win one prize a month.

  Work on the basis that all those prizes will be £25. Even the chance of winning a £50 prize is vanishingly small – it will probably never happen. But you will, on average, win twelve prizes of £25 every year…. i.e. you’ll get £300 interest on your investment of £24,500…. on average. That’s 1.22%, tax free. Of course, some years you’ll be lucky and get more than £300, and some years you’ll be unlucky and get less. But most of the time you’ll get between £200 and £400, and over a few years you should average pretty close to £300.

  So my point is, for investments £20,000+ you actually fairly reliably get 1.22% interest, give or take (with a little variation, year to year). Of course, the headline rate is 1.4%, and that extra 0.18% is what you’re gambling on getting a big prize (like £100, or £1,000,000). Assume you never win on that gamble (you probably won’t). So that extra 0.18% is probably money down the drain. But 1.22% tax free is still a pretty decent deal right now.

  Three’s a reason why the maximum holding is capped at £50,000….

  roy

  • Joseph Heenan says:

    9 Jun9 June 11:15

    Money saving expert have a calculator that’ll help you figure out the pros/cons of premium bonds for your exact situation, including comparing it to ISAs/savings accounts based on your tax situation:

    https://www.moneysavingexpert.com/savings/premium-bonds-calculator/

    They mostly reckon the median return (which is arguably more representative than the mean average return) is a bit lower than your 1.22%. Probabilities is a notoriously complex and unintuitive area…

    There’s pretty much no doubt it’s a good deal for higher rate tax payers, especially if ISA allowance already used. The current 1.4% interest rate doesn’t seem sustainable in the current environment though.

    • Roy says:

      9 Jun9 June 22:28

      Probabilities is a notoriously complex and unintuitive area.

      Absolutely. I think that the the MSE calculator is median for a year. I still think that I prefer my approach for evaluating longer term holdings – but I haven’t thought about it enough to have a strong opinion.

      As for tax – remember that these days, with the personal savings allowance, even higher rate tax payers get £500/yr interest tax free….. for the vast majority of people the tax advantages of a cash ISA are zero. ISAs might still be worthwhile (sometimes) but mainly because providers are willing to offer market-leading rates on them, for a whole host of reasons…

      • Rob says:

        9 Jun9 June 22:45

        That £500 allowance gets eaten up quickly if rates rise, though, and an unused ISA allowance is lost forever.

    • Roy says:

      9 Jun9 June 22:31

      The MSE calculator is great for forcing people to be realistic. Particularly for smaller investments where MSE will (correctly) tell you that your mean annual return is….. zero.

  • Crafty says:

    10 Jun10 June 13:53

    Thank you Roy, this a very helpful analysis.

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