Losing interest in ERNIE

It is a great sales pitch – a no-lose gamble that could change your life.

Premium Bonds offer two chances a month to scoop £1 million with more than 1.5 million other prizes of between £50 and £100,000 up for grabs. Unlike the National Lottery, you don’t kiss goodbye to all your money if your number doesn’t come up.

What’s more if Ernie (the computer which makes the monthly draw) does you a favour your winnings will be tax free. With the credit crunch eating holes in family budgets, could this be the safe haven you’re looking for, the ideal place to invest your hard-earned cash?

National Savings & Investments (NSI) certainly hopes so and has just struck a deal with WH Smith to promote them in 150 branches. But the truth is you – and the vast majority of the 24 million people who already own bonds – would be much better off investing elsewhere.

The reason is that no matter how many bonds you own and no matter how long you keep them you’re not guaranteed to win anything. And if you don’t get lucky the true value of your money will be shrinking in line with inflation.

The precise number of winners in each prize band – apart from the £1million – varies each month depending on the number of bonds in issue.

But the value of the pot is equivalent to one month’s interest on the total value of eligible bonds at an annual interest rate, currently 3.4 per cent.

This means if you owned all the bonds in existence you’d get 3.4 per cent interest. But the way the draw works means prizes are dished out randomly. So some investors will receive more than that while others miss out altogether.

Another reason for this is that the minimum prize is £50. So while someone with a minimum £100 investment could, with average luck, expect a return of £3.40 this simply isn’t possible.

While the more bonds you own, the more chance you have of winning the current odds of landing any prize at all are 22,000-1. But even if you are one of the luckier ones the chances are you could still earn more by investing your money elsewhere.

Even allowing for the fact that premium bond prizes are tax free, a basic rate taxpayer would only need to earn 4.25 per cent gross from a savings account to match the average 3.4 per cent return. In the current climate, with banks eager to attract savers’ cash to help ease the credit squeeze, that is easy.

NSI’s own Direct ISA is currently paying 5.3 per cent while Birmingham Midshires has a no-notice internet account paying 6.5 per cent with a minimum investment of £1.

A top-rate taxpayer would need to find an account paying 5.65 per cent to match the bonds – provided they have average luck. So for them – provided they have used their ISA allowances – bonds could hold some attraction.

But don’t forget – the interest rate quoted by National Savings & Investments is a bit misleading. Most people win much less because, as I’ve said, that figure is boosted by a tiny number of jackpots and other payouts are skewed by the way prizes are dished out.

There is, of course, the chance of winning a million but the odds of that are around 20 billion to one for each pound invested. So if it’s a flutter you’re after – the lottery’s 14 million to one odds of hitting the jackpot seem positively generous!

By Clinton Manning

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