Investors gamble for high stakes on a no-risk lottery

Premium bonds: Rachel Fixsen considers the odds and returns

Imagine an investment which might or might not give you a return. You would not be impressed. But if you found out we were talking about premium bonds you wouldn't be surprised. After all, they are nothing more than everlasting lottery tickets - certainly not serious investments. Or are they?

More than 85,000 people take premium bonds seriously enough to have the maximum holding of pounds 20,000 of them. Some 350,000 invest pounds 10,000 or more.

Bonds, which are part of National Savings, work by ploughing money, equivalent to one month's interest on all the bonds, into a monthly prize fund. Every month there is a draw for various cash prizes, ranging from pounds 50 to pounds 1m. Each pounds l unit has an equal chance. The minimum purchase is pounds 100 and you can hold up to pounds 20,000.

The serious investor hopes for a good return by winning a steady number of prizes - and has the excitement of hoping for a really big win. Prizes are tax-free, bonds can be cashed in at short notice and are backed by the Government - three points which attract investors.

As for your chances of winning, you would have to wait 1,814 years before being statistically likely to win anything at all if you only had one pounds l unit. You'd have to hold out for 635,000 centuries to win pounds 1m. The more you have, the more chances you have of winning. With pounds 20,000 in bonds, you should win 11 prizes a year on average .

The rate of interest applied to the prize fund is currently 4.75 per cent per annum. However, because the pounds 1m prize takes up a large part of the monthly prize fund you are statistically more likely to average 3.75 per cent on your pounds 20,000 holding. This is equivalent to 6.25 per cent gross for higher-rate taxpayers.

You could be very lucky indeed. One pounds 20,000 investor says his average return is twice or sometimes three times the amount you would get from a savings account. "I found it was a very good investment -all tax free and you don't even have to bother declaring it."

The odds have lengthened for investors since May last year, however. The number of monthly prizes has been fixed at 350,000, while the increase in bond sales since the pounds 1m prize was introduced have raised the odds of a single unit winning any prize to around 41,000 to one from 15,000 to one. The upside to this prize structure change, made for administrative reasons, is that winners on average get bigger prizes. Even so, Rebekah Kearey of Roundhill Financial Management in Brighton says: "There was a lot of bad feeling among my clients when they made this change."

Is anyone unlucky enough to win nothing on a pounds 20,000 investment? A National Savings sample of bond holders before the changes found one holder won 32 prizes in oneyear, and one got nothing at all. The average was 15 or 16 prizes.

A pounds 20,000 investment would now be expected to win 11 prizes in any one year.

"But the bottom line is you always get your money back," stresses Malcolm Andrew, of National Savings.

Keith Sanham, of London-based financial planners Sanham & Co, points out that your stake, which you do not get back, is the interest you give up on your capital. If you held pounds 1,000 in premium bonds your annual stake would, assuming you could get 4.5 per cent per annum interest in a savings account, be pounds 45 in what is essentially a gamble.

Some say premium bonds are simply an alternative to the National Lottery and have never been satisfactory investments.

Roddy Kohn, of Bristol-based financial advisers Kohn Kougar, says his firm has hundreds of clients with the maximum holding. "We're finding that very few of them are actually winning. They've found it very intermittent," he says.