One well known principle of investing is that spreading ones money reduces exposure to any one asset class and therefore reduces risk.
It is with that in mind that we at Ovation have always been quite happy to see clients’ build up cash investments such as Premium Bonds as offered by National Savings & Investments. But what sort of returns does this investment actually give?
Before asking that question we must place Premium Bonds in their rightful place on the risk spectrum. One reason that many people invest in Premium Bonds is because the capital will not go down. The return on the money may not be as important to the investor/saver as the fact that they will get their money back.
But will they? £10,000 invested over ten years that returns £10,000 might give a return of capital, but it is a reduction in real terms. Inflation over that period will have reduced the buying power of the money. Even the very lowest risk investment still carries some risk. That’s why any scale of assessing risk starts at 1, and not 0.
At the time of writing the Consumer Prices Index (CPI, the standard definition for inflation) is 1.9% (as at January 2014, source Office of National Statistics). Any investment needs to return at least this amount, after any tax, to maintain its purchasing power.
So given that the lowest risk investments need to generate a return, analysing the performance of National Savings and Premium Bonds is relevant.
The annual prize rate of Premium Bonds is 1.3%, already well below the CPI. So does this mean that anyone with Premium Bond will get a return of 1.3%? No it does not. This is because Premium Bonds are a type of lottery.
One person might win big on Premium Bonds. But for that one person to receive a large return on their money, many others will have to win nothing. So for most people, the return is considerably less than 1.3%.
In the favour of Premium Bonds is the fact the returns are tax free – if and when they arrive. There is also the guarantee of your money back (minus inflation). And, of course, the possibility of a large win.
Also at the time of writing the best easy access cash ISA offers an interest rate of 1.75%. Still not enough to keep pace with inflation, but a lot closer than the likely returns offered by Premium Bonds.
Maybe it’s time to consider maximising those cash ISA allowances each year, and using some of the extra interest to buy lottery tickets?
Please note that the information contained in this article was taken from a piece by Martin Lewis in the Daily Telegraph on 19thFebruary. The full article can be read here