NS&I premium bonds – what are your investment alternatives?

The combination of two £1million monthly jackpots and a government-backed guarantee can make a compelling argument for investing in NS&I's premium bonds.

Rather than paying interest like a savings account, premium bond holders are entered into a monthly draw for tax-free cash prizes ranging from £25 to £1 million. Each of the NS&I bonds costs £1 and you can invest between £100 and £30,000, rising to £40,000 from 1 June 2014. The bonds are protected by a government guarantee and you can cash them in at any time.

However while NS&I's premium bonds can undoubtedly provide a fun alternative to a savings account for children or grandchildren, the odds of winning are so low that they may not stack up as a serious long-term investment.

What are the odds?

According to National Savings the odds of any £1 premium bond winning a cash prize is 24,000 to one, while the odds of winning the jackpot are an unlikely 44 billion to one. This compares with a one in 14 million chance of winning the main National Lottery ‘Lotto' draw.

NS&I points out that the prizes paid to bondholders equate to an equivalent interest rate of 1.5% - compared to some savings accounts this doesn't look too bad. However it is a figure that should be taken with a pinch of salt – a lucky few will earn a rate way in excess of this, but you could get back far less.

Government backed safety

Historically the government guarantee that protects bondholders' money has been a major attraction for cautious savers but even this should no longer provide a reason to invest in the NS&I bonds with the Financial Services Compensation Scheme protecting the first £85,000 in any UK savings account (twice that in joint accounts).

The alternatives

For savvy savers there are numerous alternatives to premium bonds. While they won't offer any chance of a life-changing windfall, they will provide a steady income, something National Savings cannot guarantee. The more you have to invest and the more risk you are prepared to take, the more you stand to earn.

Savings accounts

Only cash on  deposit can be regarded as ‘safe' as premium bonds in so far as you won't see the value of your holding fall and – depending on the account you choose – you can have instant access to your money.

So long as interest rates remain so low, savings accounts are never going to give your money a dramatic boost, nonetheless they are the only sensible option if you need short-term access to your cash or can't afford to see its value fall. Maximise returns by chasing the best rates and making the most of your annual ISA allowance to ensure all interest is paid tax-free.

Find the best cash Isa or savings account for you

Corporate bonds and gilts

Fixed interest securities are loans to companies – in the case of corporate bonds – or governments - in the case of gilts – which pay interest in return over a certain duration.

Bond funds pool your money along with that of other investors to invest in a variety of fixed interest securities.

Traditionally corporate bond funds have been regarded as a lower risk investment and in recent years they have performed well for investors, generating an income in the region of 5-6%. However Patrick Connolly, head of communications at IFA Chase de Vere warns that this position is changing. "Prices have been boosted by quantitative easing and by their popularity in recent years, with people prepared to buy them at any price. As a result they are expensive and there is a strong chance that the capital value will fall."

In the current climate he says investors can expect yields in the region of 3-3.5% from investment grade bonds, rising to 6-6.5% with riskier high yield bonds.

Equity income funds

Stockmarkets offer the potential for greater returns – but there is always the risk that the value of your money will fall at some stage which means they are only suited to investors who can afford to tie their money up for at least five to 10 years. This means you have time to ride out the ups and downs.

Equity income funds pool the money of numerous investors and buy shares in dividend paying companies.  "Investors can expect a typical income of 3.5-4% but you would hope for capital growth too," says Connolly.

The majority of equity income funds invest in UK companies, however in recent years more fund managers have launched global and region specific income funds too.

Risks will vary according to the fund and it's remit, those investing in large UK blue chips will be considerably less risky than those focusing smaller companies or emerging markets. The more risk you are prepared to take, the high the potential income you can generate.

Where should I invest?

Diversification is the key to successful long-term investment – when one asset class is performing badly your entire portfolio won't suffer. "The right solution is an investment across all these asset classes in proportions that suit your appetite for risk," advises Connolly.

There's no harm in holding some premium bonds in the hope of a big win – particularly for higher rate taxpayers - but they shouldn't form a part of your long-term savings plan. As Connolly says: "There are no guarantees and you could potentially get nothing back."

Your Comments

Many of us appreciate that the chance of a big win is very small but we are happy to have smaller wins. I'm averaging 1% pa which is not a lot less than the best savings account and I have the entertainment value every month that 'it could be me' for the million.