Is it still worth putting money in Premium Bonds?

Some 22 million Britons hold Premium Bonds, making them the most popular savings product in the UK.

So it matters that the potential returns on Premium Bonds are falling. From the next Premium Bonds draw at the start of December, the prize fund rate (explained below) will reduce from 4.4% to 4.1%, while the odds of winning any prize from a single Premium Bond will move from 21,000 to 1 to 22,000 to 1. 

How much do these reductions change the equation for those weighing up whether to put their money into Premium Bonds, and what alternatives might offer a better home for their money?

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4.1% in prizes - but will you get that?

Premium Bonds don’t pay interest but pay out prizes instead. That makes a straight comparison with other cash options tricky, but you can make an informed choice between the two if you understand how Premium Bonds work.

Issued by National Savings & Investments (NS&I), the state-backed savings provider, each Premium Bond is worth £1 - although the minimum amount you can purchase is £25. Bonds are entered into a monthly draw with prizes ranging from £25 to £1million. NS&I publishes an ‘annual prize fund rate’ which is the average return received by Premium Bond holders each year via prizes, although you won’t necessarily get that rate - this is a prize draw after all.

That 4.1% represents the mean average return - the total in prizes paid out each year as a proportion of the total held in Premium Bonds. But bear in mind that the total includes a great many larger prizes that accrue to a small number of winners, meaning most holders don’t get anything.

Because of the way Premium Bonds work, the more bonds you have the greater the chance you have of achieving - or exceeding - the prize fund rate. The best analysis of this is generally recognised to come from Martin Lewis, the TV money saving expert, who advises that only those with many thousands - or even tens of thousands - of pounds in Premium Bonds will achieve a return approaching the prize fund rate, providing they have the average level of luck.

If you have less than that to put into them then Premium Bonds are, statistically speaking, likely to pay you less than the prize fund rate.

Are cash savings accounts better than Premium Bonds?

The highest paying cash accounts right now offer interest rates some way clear of the Premium Bonds prize fund rate. The best easy-access, non-ISA account pays 4.85%¹ while the highest paying equivalent Cash ISA returns 5.17%.

It’s clear that, based purely on the return you’re likely to get, Premium Bonds are not the most lucrative choice. Some, of course, will value having the chance of winning a big prize each month and may be willing to forgo a few basis points of interest to get it.

Tax: another benefit of Premium Bonds?

Another key attraction of Premium Bonds is that prizes are tax-free. That compares to non-ISA cash accounts where interest above the Personal Savings Allowance is subject to tax at your marginal rate of Income Tax. Basic rate taxpayers get an allowance of £1,000, higher-rate taxpayers get £500 and additional rate taxpayers get zero allowance.

Returns within Cash ISAs are also tax-free, of course, but any money you hold in Cash ISAs detracts from your £20,000 annual ISA allowance. That may be fine if you do not intend to use your allowance for investments.

For those who do, however, Premium Bonds can be useful because, despite the potential lower return they offer, prizes will not be taxed.

Where next for cash interest and the Premium Bond prize fund rate?

Interest rates of all kinds are on the way down. Our round-up on how far interest rates will fall lays out an explanation of why.

The Premium Bond prize fund rate is ultimately set by NS&I according to a government mandate which requires it to balance some competing priorities. It needs to offer savers a safe home for their cash with competitive rates. However, it must not distort the market for cash savings by offering rates far above private sector competitors. The fact that rates are falling elsewhere probably means rates on NS&I products will fall as well.

Additionally, NS&I must set rates in order to provide a pre-determined level of financing for the government - which means rates will be made less competitive once enough money has been attracted to Premium Bonds. NS&I confirmed in July that it exceeded its financing targets in the preceding year and will lower its targets next year, meaning rates on NS&I products, including Premium Bonds, are likely to be less competitive in the near future.²

Is it time to reassess you allocation to cash?

With rates on cash likely to fall, is it time to rebalance your allocation of cash versus investments?

Cash and investments both play an important - and different - role - in your financial mix. It makes sense to hold a sum of cash that you can dip into in an emergency - an amount worth three to six months of income is recommended. This actually helps your investing because it means you won’t have to sell investments to produce cash in a pinch.

Beyond that, it can also make sense to hold cash on the sidelines that you are willing to use to take advantage of investment buying opportunities as they arise. Cash will not lose value in nominal terms (although it can lose value to inflation) whereas investments can fall in value.

The compensation for taking that risk is the potential that investments can produce a higher return - with the chance, of course, that they don’t. In point of fact, the Legal & General Global Equity Index Fund, a low-cost fund from our  Select 50 which reproduces the performance of global stock markets, would have significantly outperformed cash over the past year, adding 19.1%³. Please remember past performance is not a reliable indicator of future returns.

If you need the potentially higher returns available from investments to make your financial plans work in the long term, loading up on cash, even if rates are beating inflation, may mean you fall short of hitting your goals. It might have made sense in the past year, when many investors will have been happy to snap up a healthy real-terms return with no risk of loss. Now rates are falling it could be a good time to reassess your balance of cash and investments.

A half-way solution might be to move cash savings to an investment account but utilise assets which produce a cash-like return while rates remain somewhat attractive. That would allow you to take advantage of the real return from cash while it lasts, but also leave you ready to switch to investments if and when that suits you.

Cash funds or money market funds held inside investment accounts can do this job. The Fidelity Cash fund is the best-selling cash fund on the Fidelity Investing platform and is forecast to produce 4.96% of income in the coming year - or 4.61% after deducting the Fidelity platform charge of 0.35%.⁴ Please note this yield could down or up and is not guaranteed.

You can also earn interest on money held in your investment account even if you don’t invest it into a cash fund. Fidelity offers interest on cash and  you can learn more about how we manage your cash here.

Past performance is not a reliable indicator of future returns

Source: Morningstar from 30.9.19 to 30.9.24. Basis: bid to bid with income reinvested in GBP. Excludes initial charge.

Source:

¹ MoneySavingExpert, 14 November 2024
² NS&I Annual Report and Accounts and Product Accounts, 2023-24
³ Legal & General Global Equity Index Fund factsheet, 30 September 2024
⁴ Fidelty International, 18 November 2024

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