Premium Bonds v. The Lottery

Premium Bonds have been in the news again recently, with the decision to pay out an extra £1 million prize every month. But are they really a good bet compared with other opportunities to win big cash prizes such as the Lottery? I thought I'd do some research on this to find out.

Let's start with the basics though. Premium Bonds are sold by National Savings and Investments (NS&I) on behalf of the government. Each Bond has a unique number and is sold for £1, though the minimum purchase you can make at any one time is £100.

No interest is paid on Premium Bonds. Instead, the interest generated is put into a prize fund. Every month the NS&I computer, the famous ERNIE, selects the winning numbers, whose owners receive prizes ranging from the minimum £50 up to £1 million. Each month over a million prizes in total are awarded.

So how do Premium Bonds compare with the Lottery? One big 'plus' for Bonds is that, once you have bought them, they are entered into the prize draws month after month, for as long as you hold them. You can also get your money back at any time - unlike Lottery tickets which, if they don't win, are instantly worthless. And, unlike stocks and shares, the value of Premium Bonds cannot go down, though of course it will never go up either.

Does the Lottery have any advantages? Well, maybe. One is that the top prize is usually bigger. If you wouldn't get out bed for a mere million pounds but wouldn't sniff at ten million, the Lottery might appeal more. Just don't hold your breath waiting for it to happen…

In addition, your chances of winning any prize with a single Lottery ticket (1 in 54) are much better than with a Premium Bond (1 in 24,000 in each draw). However, the minimum prizes with Lottery tickets are smaller - and your Premium Bond will be in entered in twelve draws a year for as long as you hold it.

Perhaps the best way of comparing the relative attractions of the Lottery and Premium Bonds is comparing the likely return on them from the same level of investment. Suppose then that you have a £30,000 windfall and invest it on (a) Premium Bonds and (b) the Lottery. What are your returns likely to be?

As from August 2005, the interest rate on Premium Bonds rose to 3.25 per cent per year. This has led some commentators to suggest that with average luck you could expect a return of 3.25 per cent on your investment. As prizes are tax-free, this would be the equivalent of 5.42 per cent for a higher rate tax-payer and 4.06 per cent for a basic rate one. Such rates would be comparable with many high street savings accounts.

I have to say this is misleading, though. That average figure of 3.25 per cent is boosted by a small number of very large prizes that, statistically, you are very unlikely to win. A more relevant statistic may be the fact that with £30,000 worth of bonds you can expect to win, on average, 15 prizes a year.

If these are all minimum £50 prizes, at the end of the year you will have won £750 worth of prizes, equivalent to an annual interest rate of 2.5 per cent tax-free. That's less than many savings accounts, of course, but every month you do have the chance of winning a bigger prize, up to the £1 million jackpot.

Now suppose that instead you invest your £30,000 on this week's Lottery draw. The statistics say that 50 per cent of all funds invested in the Lottery are returned as prizes. Again this is misleading, however, as a significant proportion of this money goes in a small number of very large prizes you are very unlikely to win.

A better guide comes from a surprising source. ITV's Saturday night quiz show The Big Call culminates in the winner being asked to choose between £25,000 and 100,000 Lottery tickets. If the winner doesn't go for the tickets, a viewer gets the opportunity instead. If you have watched the show, you will know that the 100,000 Lottery tickets typically produce around £30,000 in prizes, i.e. you get a return of 30 per cent.

Going back to my example, then, if you put your £30,000 windfall into Lottery tickets, with 'average luck' you could expect to get 30 per cent of 30,000 = £9,000 back. By contrast, with average luck again your £30,000 Premium Bond investment would give you a total return over a year of £30,750 (including the value of the Bonds, of course).

When you look at it like this, the Lottery really is a terrible investment. OK, it might be a bit of fun if you have no other use for a spare pound or two, but if you are spending any more than this, you should really consider saving up and buying Premium Bonds instead.

After all, think about it. With Premium Bonds you still get the chance to win a life-changing sum of money, but even if this doesn't happen they are still a decent investment, and you can get all your money back any time you need it.

If you're paying for Lottery tickets every week, therefore, my suggestion would be to put the money into a separate kitty instead and use it to buy Premium Bonds. The more you have, the better your chances will be, and every month your Bonds will be in with as good a chance of a big win as anybody else's. Be lucky!

* You can buy Premium Bonds at any post office or at the NS&I website at www.nsandi.com. If you already have Premium Bonds, you can also use this site to check whether they are holding any unclaimed prizes for you.