Premium Bonds, which are issued by National Savings & Investments (NS&I), cost £1 each. They do not pay any interest. Instead, each eligible bond is entered into a monthly draw for prizes ranging from £25 to £1m. However, the odds of any bond winning a prize are 24,500 to 1. Given the fact that Brits have invested over £84bn in Premium Bonds, those odds do not appear to matter to them.
It is true that the more bonds a person owns, the higher the chance of a prize. Also, the UK Treasury backs any savings and prizes won, so an investor will never get back less than they put in. Additionally, Premium Bond prizes are entirely tax-free. But what kind of returns can an investor in Premium Bonds expect?
Tried and tested
Let’s look at how a £100 per month Premium bond investment, over 25 years, is likely to perform. First, we need probabilities of winning each of the monthly prizes available, and the chance of winning nothing. The required data for calculating these is available on the prize draw details section of the NS&I website.
We will start with 100 bonds that go into the monthly draw. Any prizes won will be used to buy more bonds, and another 100 bonds are purchased each month. There is a limit of 50,000 eligible bonds – anything over this amount is ineligible for the prize draws, and we will do the same in our study.
Ten thousand trials of this experiment are enough to generate some expectations. On average, the wealth level at the end of 25 years was £36,040. 10% of the trials generated a wealth level of £36,625 or higher. 1% of trials resulted in netting £40,950 or more. The truly lucky, the 0.1% club, could expect their investment to grow to £91,825 or more, with one (0.01% of trials) sitting on £1,036,150.
99% of the time, investing £100 per month for 25 years in Premium Bonds will generate £40,950 or less. An investor can do better than this is they find an investment that returns 2.43% each year on average.
The good news is that there are investments out there that have long-term average returns that beat 2.43%. The FTSE 100, with dividend reinvestment, had an average return of 6.4% over the last 25 years. Investing in the FTSE 100 with a low-cost tracker fund, held inside an ISA, would mean most of that return accrued to the investor.
There are individual stocks like Unilever and RELX that have delivered 10-year average returns of 11.58% and 16.89% respectively. Both of these are fancied by Nick Train, a fund manager with exemplary performance, and are considered sustainable dividend payers. Both of these stocks can be held inside an ISA, as could other suitable picks.
Of course, there are risks with stock market investing, and more so with investing in individual stocks. You could get back less than you put in, which is not the case with Premium Bonds. However, I don’t believe it is controversial to say you are more likely to end up with more wealth if you invest for the long term in the stock market inside an ISA, compared to investing in Premium Bonds.
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James J. McCombie owns shares in Unilever. The Motley Fool UK owns shares of and has recommended Unilever. The Motley Fool UK has recommended RELX. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.