As Ernie hits 50, premium bonds never had it so good

Now more popular than ever, the savings lottery has come a long way since it was condemned in 1956 as 'a squalid raffle'. But are today's investors really on to a winner?

A certain Bond, known for his love of gadgets, women and champagne, has dominated the headlines over the past few weeks since Casino Royale hit the UK's cinema screens.

But another type of bond has been making a splash, too. Last month marked half a century since the Conservative government under Harold Macmillan introduced premium bonds, the state-backed investment lottery that today is run by National Savings & Investments (NS&I).

Back in 1956, not everyone was celebrating the launch of the scheme. Harold Wilson, then shadow Chancellor, called it "a squalid raffle", while church leaders voiced their concern that Britain could become a nation of gamblers.

But 50 years on, premium bonds have gone from strength to strength; more than £32bn is invested in them, and 23 million people hold out for a win.

Thanks to creative advertisements - a growling Sir Alan Sugar has recently been extolling their benefits - and deals such as a tie-up with Tesco, more premium bonds have been sold in the past five years than in the previous 45, according to financial analyst Moneyfacts.

The rules remain simple: holders must invest a minimum of £100 (the maximum holding is £30,000) to buy numbers that are entered into a draw made by a computer called Ernie - which stands for electronic random number indicator equipment.

Like their cinematic namesake, the bonds have been revamped in recent years to keep the punters coming. A £1m jackpot was introduced in 1994 in response to competition from the National Lottery. Then, in 2002, NS&I began selling premium bonds over the phone and internet. And only last year, the scheme was given another boost with the introduction of two £1m jackpots every month.

There are extra prizes on offer this month to mark the 50th anniversary, including three special £1m jackpots. An estimated total prize fund of £101m will be paid out this month.

Independent financial advisers (IFA) are usually quick to warn consumers off all forms of gambling, but are far more relaxed about premium bonds.

"Premium bonds appeal to the natural gambler in most of us," says Justin Modray from IFA Bestinvest. "And unlike most forms of gambling, they have the added advantage that you cannot lose your initial stake money."

But before investors get too carried away, they should consider the downside of putting money into a lottery.

The principal appeal of premium bonds is the chance to win tax-free prizes up to £1m without putting your capital at risk. But the chance of an individual bond winning a prize is currently 24,000 to one.

To win the £1m monthly jackpot with a £100 investment, you will have to beat odds of 156 million to one, says Mr Modray.

However, with "average luck", says NS&I, a premium bond holder with the maximum £30,000 invested could at the present time expect to win 15 prizes a year, with a minimum single prize of £50.

"About 315,000 people now have the maximum £30,000 invested," says Elen Thomas, spokeswoman for NS&I.

Some bondholders will be luckier than others. This is where the cost of entering the lottery starts to bite. Put your money into premium bonds and, in contrast to cash or equity investments, you receive neither interest nor dividends. Inflation, too, can destroy the real value of a holding.

"Too many investors overlook the risk that inflation will erode their investment if they don't enjoy a win," warns Mr Modray. "For example, average inflation of 2.5 per cent over 10 years would reduce £100 to £77 in real terms - and just £60 after 20 years."

NS&I makes much of what it calls its "monthly prize fund", a variable payout calculated by working out one month's interest on the total value of all eligible premium bonds. The rate rises or falls in line with movements in the base rate.

Interest on the fund will rise from 3.15 per cent (tax-free) last month to 3.55 per cent for the draw in December, so boosting the payout. It then slips back to 3.4 per cent in January.

Since the prizes are tax-free, any win can be interpreted as being worth more than the face value: higher-rate taxpayers will thus get an additional 40 per cent.

But Mr Modray says that while such tax breaks are "obviously advantageous", premium bonds are "certainly not worth buying for the tax breaks alone".

He urges consumers to weigh up the pros and cons. "On the plus side, the gambling element encourages some individuals to save who wouldn't otherwise do so. But unless you strike gold, you're unlikely to enjoy particularly attractive returns."

The main beneficiary, he points out, is the Government - selling premium bonds is a cheap way for it to borrow money.

But NS&I's Ms Thomas is adamant that consumers benefit. "Premium bonds have been marketed as 'savings with a thrill'," she says. "They were introduced as a novel way to save, and they have gone from being regarded as equivalent to a lottery to being regarded as a serious investment."

There are more than 514,000 unclaimed premium bond prizes, worth more than £30m; the largest is £25,000. Investors can check to see if a prize is due to them by writing to NS&I or looking on its website.

Premium bonds can be bought online at www.nsandi.com, by phone (0500 007007), by post (NS&I, Blackpool FY3 9YP), and over the counter at Post Office branches