We all know that interest rates are depressingly low for savers (though good news for borrowers). There has been some coverage of National Savings Premium Bonds which has been rather unfavourable, so I thought that I would provide my thoughts on this.
As with all cash deposits, cash as a long-term investment strategy is not a good idea. Why? simply because of inflation. If interest rates are 2% and inflation is 3% then in real terms you are losing money each year, by losing I mean your £1 has less purchase power. So can we agree that cash holdings are for emergency funds, for people that are very anxious about other forms of investing and for planned major expenses. There are no rules or rights or wrongs, but holding cash is sensible for anyone, as it provides liquidity (rather than having to borrow or sell assets).
Turning to Premium Bonds. These are very basic, you buy each bond for £1. You can hold up to 30,000 so £30,000. You are not guaranteed any interest – indeed there is no interest at all. However, your £1 bond with its unique number is automatically entered into a draw. Each month someone wins £1m. Most don’t win at all, but in general those with the full £30,000 allowance tend to win small prizes, which over the year amount to about £450 (1.50% of £30,000). This money is tax free. So for a 20% taxpayer is equivalent to 1.875% gross and a 40% taxpayer equivalent to 2.50% gross. These rates are best compared against monthly interest paying accounts with 30 day notice. You will find very few accounts paying these sorts of rates. Sure a little bit more in a few instances, but not much. Given that we are talking about £30,000 an extra 0.5% is worth £150 over a year… not a significant sum when you consider that it would be taxable, involve the hassle of opening a new account and removes you from the possibility of winning £1m. I might add, that it is also a bit of fun, opening an envelope to discover your winnings. More fun than opening a bank statement, or indeed one of our portfolio valuations (unless you find particular joy in this exercise). Last month someone won £1m, 5 people won £100,000, 9 won £50,000, 18 won £25,000, 48 won £10,000 and 93 won £5,000. The smallest prize (£25) was paid out to nearly1.8m people in June alone.
The news is that the chances of “winning” (from £25) will reduce from 24,000:1 to 26,000:1 on August 1st 2013. As a result the current appropriate 1.5% rate is now more like 1.30%. So on £30,000 you might expect £390 of tax free winnings over a year. To a basic rate (20%) taxpayer this is equivalent to 1.625% and a 40% taxpayer equivalent to 2.16%. These are still decent rates. Sure nothing to write home about, but pretty competitive never-the-less.
Yes the rates are poor, but then that’s true of all similar types of accounts. As I have said cash is not a long-term investment strategy, it is a helpful emergency reserve and buffer. Whatever the economic climate, holding some cash would be entirely sensible. The question is really about having a properly thought through investment strategy that enables you to achieve your goals.
So please remember, this is not advice to rush out and buy premium bonds. This is my opinion in response to some negative coverage about them.Unlike the lottery you get your money back, the same money is re-entered into the draw each month. For the record, none of our clients have yet won the £1m jackpot and I would not advise anyone to rely on winning a jackpot as an appropriate form of providing for your future…that’s just wishful thinking.
Dominic Thomas: Solomons IFA
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