April was not a good month. Even though I will pay less tax this year and I am lucky enough not to rely on frozen benefits or indeed frozen pay. But I did not win a prize in the April Premium Bond draw! That is unusual. The odds say I should win one or two prizes each month. I put a brave face on it because from May the prospects for us premium bond investors – but not for premium bond gamblers – are looking brighter.
That may seem odd because from May the interest rate on premium bonds falls from 1.25% to 1.15%. That interest is put into a fund which is used to pay out the prizes. The size of that fund is predicted be about 10% less in May than in April. But, and it is a very big but, I will be more likely not less to get a regular return on my investment.
Time to ‘fess up. I like National Savings and I do have a lot of Premium Bonds. Having one or two, or that £100 your mum gave you or even the £5000 you once bought with a bonus are not really the essence of Premium Bond investing. You need loads, the maximum, £50,000. Then the law of large numbers (there really is one) begins to work and when I say ‘chances are you’ll win x prizes in y years’ that is more likely to be true in any given year the more premium bonds you have. If you had an infinite number it would always be true. But £50,000 is not a bad approximation.
Why does a lower interest rate and a smaller prize fund give me a bigger chance of winning? Or, to be completely accurate, a bigger chance of winning the smallest prize, that workhorse of premium bond investing, £25. Millions of those are paid out each month compared with just thousands of all the other prizes. In April a total of £70m was paid out in prizes. In May it was less than £66m. But there will be more £25 prizes – 122,442 more taking the total from 2,117,718 in April to 2,240,160 in May. The lower value prizes £25, £50, and £100 account for a fixed 90% of the prize fund. But National Savings & Investments has confirmed to me that the £50 and £100 prizes will be reduced in number – from more than 72,000 each in April to fewer than 22,000 in May – and that the number of £25 prizes will grow accordingly. That is why winning one of those will become slightly more likely.
If you had the maximum £50,000 bonds before May you were likely to win 18.7 prizes of £25 per year. In May that rose to 19.6 per year. But you will wait more than five years for a £50 or £100 prize compared with well under two years before. Those three are the only prizes you need worry about. Before or after May it will still be a human lifetime (87 years now, was 80 years) before you can expect to win £1000 and several thousand years for a £5000 or £10,000 prize. And the million pound prizes? Forget it. Ice ages are more frequent.
So that £25 workhorse is going to plod along a little more quickly from May. The effective rate of return if you only ever win £25 prizes is 0.98%. Taxfree. Which is the same as 1.22% if you pay basic rate tax and 1.63% if you pay higher rate tax and 1.78% if you are one of the lucky few on over £150,000 a year paying the 45% rate of tax. Before May it was 0.93%.
Of course the first £1000 of interest on all your savings is tax-free anyway (£500 for a higher rate taxpayer). But I am guessing that if you have £50,000 to put into Premium Bonds you probably have a quite a bit of other cash sloshing around and have already used up that allowance. If you are really lucky and pay the 45% additional rate tax then you don’t have a personal savings allowance anyway. Even without a tax saving Premium Bond interest rate of 0.98% is not bad for an instant access account – just outside the top five and better than the 0.75% NS&I now pays on its income bonds.
So that is why I say the new structure will favour investors rather than gamblers who will wait even longer for the big prizes.
If you had bought £50,000 bonds to celebrate killing one of the last woolly mammoths 12,500 years ago you might expect to have won one £25,000 prize by now. Your even more distant ancestor who did the same after she spent a passionate night with one of the last Neanderthal men 55,000 years ago might expect to have won one £1m prize by now and probably one £100,000 one as well. As I am 2.3% Neanderthal I like to think she was an ancestor. From May the £5000 prizes only come along every 2361 years – the time of Dionysius II – and £10,000 every 4825 years – lucky to win once since the Great Pyramid at Giza was built. On average. If you have the max.
If you just have the £100 your Mum gave you on your 5th birthday with visions of you being a millionaire one day then you will be 30 before you get your first £25 prize. You will need more than the patience of a saint or even one of the first saints, the Prophet Ezekiel from around 600 BCE, to get a £100 prize (once in 2677 years) and you will wait nearly 28 million years to get the big £1 million. If you had bought 10 Premium Bonds the year the dinosaurs were wiped out 66 million years ago you would probably have won just one £25,000 prize and nothing bigger.
So Premium Bonds are a rubbish gamble. Forget the big prizes; they will never be yours. Max out on Premium Bonds and check them every month for that small, tax-free income stream that is guaranteed. Not just by the UK Government. But by the laws of mathematics as well.
This is an updated version of my piece in FT Money 13 April 2017
1 May 2017