FIVE months ago i transferred money that was in cash savings accounts to premium bonds.
Like many others, I was able to find that my level of interest in my money was lower than inflation and I figured that I didn’t have much to lose by trying to earn money. Premium Bond price instead. I wrote about the ruling at the time.
I hadn’t really seen premium bonds as a serious bang for my buck before this. In truth, they struck me as more of a novelty than a good place to keep my savings.
Issued by National Savings & Investments (NS&I), the state-backed savings provider, a premium bond can be purchased for £ 1. The bonds are then submitted to a monthly raffle with prizes ranging from £ 25 to £ 1million. The minimum you can buy is £ 25 of bonds and the maximum you can hold is £ 50,000.
It is worth saying what money I am talking about here. This is the bulk of my savings in cash – I also have money that I invest that is separate. There are very good reasons to hold a good amount of cash even if you are ready and willing to invest, which I explain a bit more below. This is the money I hold for real emergencies like lost income. This can help me out if needed and means I don’t have to sell investments in a pinch. It should be easily accessible to me and protected against the loss of its cash value, so I did not consider investments, where there is a risk of loss, as an alternative for him.
To understand if the bet was worth taking, I needed to assess how the potential return on premium bonds compared to the interest I could get from a savings account. My savings at the time were in an account that only paid 0.5%. It was competitive back then, although the best rates now on an equivalent account climbed to around 0.65%. The interest could be lowered by the bank, but was otherwise guaranteed.
Determining how much premium bonds are likely to pay in price is a much less certain exercise. The potential return on premium bonds depends only on whether you win prizes. NS&I’s website explains exactly what prices are offered, but it also publishes the “annual price fund rate” – a number designed to show the average return of a person who owns premium bonds. The annual fund price amount is currently 1%.
This figure should be treated with caution. It is certainly not equivalent to an interest rate and only represents the average average price return, so included in that average are the people who win prizes of £ 1million, which skews the figure. In fact, the vast majority of Premium Bond holders earn nothing. However, the price system means that those who hold a higher number of premium bonds are more likely to win and more likely to reach the fund’s annual rate of 1% of the price.
If you really want to, you can read more about the odds of winning at the Moneysavingexpert.com website, which heroically crunched the numbers. But to sum up a long and complicated story, those with around £ 20,000 of premium bonds can realistically hope to hit the 1% rate if they like the average level of luck. This is a raffle, after all, so you can own the maximum £ 50,000 allowed and still lose if your luck is bad.
Based on these odds, I knew that the amounts I could invest in Premium Bonds gave me a good chance of getting a 1% return – and let’s remember I only needed 0.5 % to match what I was getting in my savings account. I was ready to take the risk.
The first draw I entered was in May – your money must be held in premium bonds for a full calendar month before being included in the draw – and I was delighted to receive an SMS informing me that I had won a prize. In fact, I had won three prizes of £ 25. Two more followed in June and August – July was my only month with no prizes.
This all means that I managed to win as many prizes in five months as I expected in one year interest from my old savings account. The bet is won! Everything I win for the rest of the year is a bonus and there is still a (very, very small) chance that I could win a much bigger prize.
The only problem is that with inflation of 2% but expected to accelerate this year, I probably won’t be able to keep pace even if my winning streak continues. I can, at least, dream of hitting a jackpot while I wait.
Cash – a valuable friend for investments
Even if you’re convinced by the idea of investing, it’s still important to understand the role that cash savings play in your personal finances – and why they can improve your prospects as an investor.
Having cash savings means you have an emergency safety fund. Experts often recommend having three to six months of cash income for rainy days.
Holding so much money in low paying savings accounts can sometimes be painful if you watch the value of investments rise, knowing that you had money in reserve that could make those gains as well. But it is still important to maintain your cash reserve.
If you know you will have money in an emergency, you can invest with more confidence that you won’t have to sell your investments because you are short of money. Being a forced salesperson of investments should be avoided because it means that you have much less ability to plan your sales in a way that maximizes earnings.
One way to reduce this risk is cash.