National Savings & Investments have reduced the interest rate used to calculate the prize fund for Premium Bonds.
The prize fund rate reduction is designed to reflect market conditions and ensure NS&I can balance the interests of savers, taxpayers and the broader financial services sector.
From 1st August 2013, the interest rate used to calculate the prize fund will be reduced by 0.20% to 1.30%.
This means that the odds of each £1 Premium Bond winning a prize will change to 26,000 to 1 from 24,000 to 1.
It’s easy to see the appeal of Premium Bonds; your money remains secure (backed by HM Treasury – although price inflation could erode its value if you are unlucky in terms of prizes), any prizes you win are tax-free and the opportunity to win prizes ranging from £25 to £1m can add some excitement to your savings portfolio.
But are Premium Bonds really a good idea?
Savers can also get tax-free returns from cash ISAs, with the most competitive 1 year fixed rate cash ISA currently offering 1.85% tax-free.
This means that, on average, savers in the ISA would be 42% better off than the return they might see from Premium Bonds following the prize fund rate cut.
Of course this is just on average; those holding Premium Bonds might experience a range of outcomes from a nil return to a £1m jackpot.
And the cash ISA option is guaranteed to lose savers money in real terms, with price inflation as measured by the Consumer Prices Index (CPI) currently running at 2.9% in the year to June 2013.
Premium Bonds might lose savers money in real terms, depending on the prize experience.
There are no easy choices for savers right now.
The Premium Bond prize rate cut probably makes little difference in the current low interest rate environment where alternative savings options are equally as unappealing.
What savers need to carefully consider is whether cash is the right home for their money, whether they are prepared to accept real terms (after inflation) erosion to their capital and whether exposing any part of their savings portfolio to investment risk is necessary to meet their financial goals.
