Are premium bonds a good investment when inflation is rising?

Premium bonds have long been a popular investment option for savers and, despite the economic uncertainty over the past 18 months, they have remained so with over 113 billion eligible bond numbers during the October prize draw. With inflation now rising and predicted to reach 4% over the coming months, premium bonds may lose some of their appeal to savers. Here we look at whether premium bonds are a good investment in the current economic climate and alternative options available.

There is no guaranteed return on the money deposited into premium bonds. Instead, premium bond holders are automatically entered into a monthly draw in which they have a chance of winning a tax-free cash prize ranging from £1 million to £25. Each month two premium bond numbers win the top prize of £1 million, with varying number of bond holders winning subsequent prizes starting at £100,000. In the October draw more than £94 million in prize money was awarded to premium bond holders. The prize winners are chosen at random, with each bond number entered. The number of bond numbers held by a saver depends on the amount of money they hold in premium bonds – with the more money held the higher the chance of winning a prize. The maximum that can be held in a premium bond is £50,000 and often those holding the maximum, or close to the maximum, appear to win the top prize. For example, in the October draw, one £1 million winner held £50,000 in premium bonds while the second £1 million winner held £49,994 in premium bonds.

Along with the chance of winning prizes, premium bonds also have the advantage of being a tax-free saving option, which can make them a good option for those who have exceeded their ISA allowance for the tax year and are concerned about exceeding their personal savings allowance. As well as this, premium bonds have the security of being backed by HM Treasury, which again makes them attractive to savers who have a high amount deposited into cash savings accounts and who may not be protected by the Financial Services Compensation Scheme (FSCS) as a result. Furthermore, as money is not locked into premium bonds, they have the advantage of allowing savers to access their funds at any time.

Savers who are starting to build a savings fund may want to consider an easy access savings account. This is because, unlike premium bonds for which there is no guarantee that bond holders will win a cash prize, easy access savings accounts pay interest, which means that savers holding even a small amount of money in an easy access savings account will earn interest on their savings. Interest rates on easy access savings accounts have, however, been at record lows over the past 18 months with the average rate standing at just 0.19%. This means it is important for savers with an easy access savings account to regularly check the easy access account comparison chart to see the best rates available and switch to a higher paying account. For example, the top rate in the easy access savings account chart available to both new and existing customers currently stands at 0.65% AER. For example, a saver with £5,000 held in an account paying this rate would earn £32.50 in interest per year.

Although easy access savings rates are a good option for those building a savings fund, once savers have accumulated three to six months’ worth of income in the account they may want to consider putting a lump sum of money into a fixed account. Fixed rate bonds usually pay a higher rate than easy access savings accounts, but in return for the higher rate savers must lock their money into the account for the fixed term. This often means savers cannot make any further deposits into the account or make any withdrawals until the account matures. Fixed accounts offer various terms, usually ranging from one year to five years, with higher rates normally paid on accounts with longer terms. For example, the highest one year fixed bond rate available today stands at 1.51% AER (expected profit rate), while the highest rate on a five year bond is 2.00% AER.

It should be noted that no cash savings account can match or beat the current rate of inflation, which stands at 3.2% (CPI) and experts predict will reach as high as 4%. Those who win a top premium bond prize will, however, gain an above inflation return on their deposits, but as already highlighted there is no guaranteed returns on premium bonds.

With cash savings rates failing to match or beat the current rate of inflation, there are no guaranteed inflation-beating returns for savers. Instead, those who already have three to six months’ income in an easy access savings account and are looking to save for the long-term may want to consider investing. Investments carry a higher risk than cash savings accounts as they do not guarantee that investors will receive a return on their investment and, in some cases, can result in them losing all their money including their initial deposit. Consumers concerned about the risk of losing their initial deposit, but who are not concerned about making a return on their investment, may be better off opting for a premium bond where their deposit is protected.

Consumers happy to take the risk of investing should remember they may be liable to pay tax on any returns they make on their investments and, as a result, may want to opt for a stocks and shares ISA which has a tax-free allowance on deposits of up to £20,000 during the 2021/22 tax year. For more information about investing in stocks and shares and how to get started visit our stocks and shares ISA page and read our guide on how to invest in shares.