Cash is a crucial part of a portfolio. It provides you with reserves to draw on for large planned or unforeseen expenses, and it allows you to take advantage of any important buying opportunities in the markets. The amount of money you hold as part of your investments – as opposed to what is in your checking account to cover current expenses – will vary depending on the size of your portfolio, the level of your regular and reliable income, and if you plan to spend a lot in the next couple of years, but many people keep 5-10% of their assets in cash.
Unfortunately, cash also seems dull. The interest you can earn is usually modest compared to the potential returns from other assets. Right now, with inflation likely to stay high and interest rates firmly on the floor, you’re guaranteed to lose money in real terms: UK inflation was 2.4% in June, up from a better rate of around 0.5% on an easy-to-access account and 1% if you lock in your money for a year. The temptation today to move your money into higher yielding investments is therefore enormous. The problem is, investments with the potential for higher returns carry more risk to your capital, and the purpose of money is to have complete security and easy access.
Popular, but not normally attractive
However, there is one popular investment that probably looks better under current conditions than usual: government-backed National Premium Savings and Investment Bonds. These don’t pay interest – instead, they hold a monthly raffle, with an annual prize rate that changes over time to reflect what’s available in savings accounts. This rate is now 1%, compared to 1.4% last year. Tax-free prizes range from £ 25 (where each £ 1 premium bond has about a one in 35,000 chance of winning) to £ 1million (about one in 55 billion). You can save up to £ 50,000 and there is no notice period for withdrawals.
This 1% price rate does not represent the typical return, as it is skewed by the handful of big prizes. Your expected return depends on the number of bonds you hold. A saver who has £ 1,000 is unlikely to earn anything in a year. One with £ 35,000 will receive on average a prize of £ 25 per month (an annual rate of 0.85%) – but about half of savers will do worse.
Flat yields like this make premium bonds quite unattractive under normal conditions. But with interest rates so low relative to inflation, even the unlucky ones won’t find themselves in a much worse situation than with a savings account. The capital is safe and there is a slim probability of a larger payoff. Very few investments that have this risk profile. As long as the price rate remains competitive with savings, premium bonds can be an easy way to make money a little more exciting without adding risk.