Six ways to beat Premium Bonds

Here are a few reasons why you might want to consider cashing in your bonds

Updated: 
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I've written before about how I dislike Premium Bonds. They are the nation's favourite savings product with £50 billion invested, but they pay no interest and the chances of winning the top prize of £1 million are 26.2 billion to 1.

I can already hear the Premium Bond fans rushing to defend this product.

Some people tell me they just like the fun of standing the chance of winning big without losing their initial stake (which you obviously do with the lottery). Well, to them I say you should rather go for a product that offers both a chance to win big and interest on your money.

If you're happy with slow and steady

Many others say they realise they're not going to win the £1 million top prize, and that they're happy with the smaller prizes. But, even the odd win here or there is unlikely to make Premium Bonds worthwhile.

That's because of the formula that decides how many prizes are handed out.

The value of the prizes on offer is decided by an interest rate that fluctuates with the Bank of England rate. It is currently 1.35%. This means that if you held every single Premium Bond in existence you could expect to win 1.35% of your total holding over a year.

Obviously, it doesn't quite work like this. So the complexities of assigning the prizes means that most people don't manage anything like a return of 1.35%.

In the current climate putting up with a savings return of less than 1.35% is madness. Interest rates may be low, but even a bog standard instant-access ISA pays 1.5%.

Here are six ways you can trounce the returns offered by Premium Bonds.

How to beat the returns on Premium Bonds:

1. Invest in the stock market
In this low interest rate environment investing in the stock market will give your savings the best chance of growing.

Use an investment ISA and your money can also grow free from income tax, capital gains tax, and most dividend tax. The average return on a stocks and shares ISA in the 2014/15 tax year was 7.4%, according to Moneyfacts.co.uk.

That is much, much better than the returns offered by Premium Bonds.

If you haven't opened a stocks and shares ISA yet this tax year you still have time if you act fast. That way you could tuck over £30,000 away from the tax man in the space of a week.

Get your ISA up and running with your money deposited in it before midnight on 5 April to use this tax year's £15,000 allowance. Then open another on the 6 April or later and you can deposit a further £15,240.

Obviously, that return does come with some risk, investments in the stock market can fall as well as rise so you could end up with less than you initially invested.

2. Go for a fixed-rate ISA
If you don't want to risk your cash on the stock market you can still beat premium bonds with an ISA. Lock your money away for five years and Virgin Money will give you a rate of 2.35% with its Virgin Fixed Rate Cash E-ISA Issue 115. The account can be opened and operated online so it isn't too late to open one this tax year.

Alternatively, Yorkshire Bank and Clydesdale Bank will pay 2.1% on their two-year fixed rate ISAs. Or, Virgin Money offers 1.65% on its one-year ISA.

3. Instant access and a better rate
Even if you want to be able to access your money whenever you like, you can still get a better rate with an ISA than you can with Premium Bonds. National Savings & Investments – the same bank that provides Premium Bonds – pays 1.5% interest on its Direct ISA.

4. Get interest plus a prize draw
Don't want to miss out on the thrill of potentially winning lots of money? Then opt for a Halifax savings account, which I alluded to earlier.

Deposit more than £5,000 into one of their eligible accounts and you can enter the Halifax Savers Prize Draw. It pays out three top prizes of £100,000 most months (some months there are bumper £500,000 prizes) plus smaller prizes of £1,000 or £100.

But, Halifax also pays you interest so you get the hope of a big cash prize plus the peace of mind of knowing your money is growing regardless. Opt for the 18-month fixed rate ISA and you'll get a rate of 1.6%.

5. Build your rainy day pot
If you are just starting a savings habit and plan to deposit a small amount each month then a regular savings account is a better option than Premium Bonds. The fewer Premium Bonds you hold the less chance you have of winning, so it really isn't worth it for you.

Instead you could go for a regular savings account. FirstDirect and M&S both pay 6% on their regular saver accounts – but you have to have a current account with them. With theses accounts you deposit between £25 and £250 (£300 for FirstDirect) each month and provided you make no withdrawals for a year you'll receive a 6% interest rate.

The best regular saver open to anyone is offered by Leeds Building Society and pays 3.05% if you deposit between £50 and £250 each month.

6. Lend your money to others
Finally, you could get a decent return on your savings and help others by using peer-to-peer lending. This is where you lend your money to businesses or individuals in return for a hefty interest rate.

For example, if you lent your money to businesses via Funding Circle you could earn around 6.4% a year. Or, lend your money to individuals with Ratesetter and you can get an annualised return of 6.3% over five years.

Money deposited with peer-to-peer lenders isn't covered by the Financial Services Compensation Scheme but the major providers such as Ratesetter, Funding Circle and Zopa have contingency funds to cover any loans that haven't been repaid.

So, there is six ways you can earn a better return than you are likely to get with Premium Bonds.

Stop chasing that £1m top prize dream, and start banking some real returns.

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