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).
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.
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.
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."
A form of National Savings Certificate, premium bonds are effectively gilt-edged securities: you loan your money to the government and, in return, it pays you for the privilege with a guarantee it will return your capital at a specified date. Where premium bonds differ is that the interest payments (currently 1.5%) are pooled and paid out as prize money and you can get your cash back within a fortnight, with no risk. Launched by Chancellor of the Exchequer Harold Macmillan in his 1956 Budget, every single £1 unit has the same chance of winning and in May 2011, 1,772,482 winners (from a total draw of 42,539,589,993 eligible bond numbers) shared £53,174,500. The odds of winning are 24,000 to 1 and the maximum holding is £30,000 per person but it remains the only punt in which you can perpetually recycle your stake money.
There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
An unexpected one-off financial gain in cash or shares, generally when mutual building societies convert to stock market-quoted banks. Also windfall tax, a one-off tax imposed by government. The UK government applied such a measure in the Budget of July 1997 on the profits of privatised utilities companies.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
Corporate bonds are one of the main ways companies can raise money (the other is by issuing shares) by borrowing from the markets at a fixed rate of interest (the reason why they are also known as “fixed-interest securities”), which is called the “coupon”, paid twice yearly. But the nominal value of the bond – usually £100 – can fluctuate depending on the fortunes of the company and also the economy. However it will repay the original amount on maturity.