DIY investment

In 1993 my grandmother, a quietly spoken woman of 101, died leaving her four grandchildren a modest bequest. I remember feeling a sudden weight of responsibility—the ultimate disrespect to her memory would be to squander the money, especially since the sum was relatively small and her life had been exceedingly long. I needed a way to feel I was doing the right thing by her, keeping her money safe and enabling it to grow. So I put most of it into premium bonds.

I chose premium bonds for several reasons—first, I’d actually heard of them (it sounds stupid, but there was no internet to help with this kind of research back then); second, I knew if I bought them I stood a very small chance of winning a lot of money; third, even if I didn’t win at least, I told myself, they wouldn’t go down in value; and fourth, anything I did win would be tax free. A lot of people appear to agree with some or all of the thinking that swayed me. Almost 22.2m people hold premium bonds, and between them they currently have just under £45bn invested—or about £2,000 each, on average.

Some 19 years later, the £12,000 I put in has turned into £17,700. This doesn’t sound too bad until you put the numbers into an inflation calculator and realise that £12,000 then would be worth around £20,500 now if my investment had just kept pace with the Retail Prices Index (RPI).

To be fair to National Savings & Investments, they make clear that if you are worried about inflation eroding the value of your savings, premium bonds might not be for you. And thanks to figures they provide, it’s clear that we devotees paid a price for sticking with them in recent years—between May and November 2008, they offered an average yield (based on the size of the monthly prize fund) of 3.4 per cent, a little below annual RPI inflation. Since then, the return has dropped steadily, reaching 1 per cent for several months in 2009 before rising to 1.5 per cent in October that year, where it has remained.

The catch is that for almost all of that period, the RPI version of inflation has bounced between about 3.5 per cent and just over 5 per cent—what used to be a return slightly below inflation has got a lot worse. “For reasons of commercial sensitivity”, National Savings & Investments doesn’t disclose how long on average people hold their premium bonds but, by way of comparison, the Treasury can borrow for 12 years in the bond markets at the same rate it now pays premium bonds holders (after adjusting for basic rate tax).

My suspicion is that most people hold premium bonds for a good bit longer than 12 years. Why don’t we sell? Part of the reason, especially today, is that selling simply gives you another headache—if not this, then what? But a bigger factor is the allure of that £1m payday, however remote. And this is the strength (from the government’s point of view) and the danger (from our perspective) of premium bonds.

One of the most powerful psychological biases among investors is the desire to make outsized returns while taking little or no risk, and premium bonds are perfectly suited to feed off this perennial weakness. So we are seduced by their apparent safety, coupled with the possibility of a huge win.

But consider this: in 1994, around the time I bought mine, National Savings & Investments offered its first monthly jackpot of £1m. Two decades later, that first million is now worth about £625,000. Fortunately for the Treasury, hope springs eternal.