Premium bonds for long term returns are absolutely terrible in respect to a stock index fund.

SneakySpectator

So if you have £50,000 in premium bonds and left it there for 20 years, the probability of all your collective wins over that period of time amounting to at least £180,000 (£180,000 wins + initial £50,000 initial deposit = £230,000 total) is 60% - 70%. 

But if you invested that £50,000 into a passive index fund like MSCI World Index that averages 7.7% return per year. After 20 years you should expect to have somewhere in the region of £230,000. So with premium bonds your chances are mediocre. While with the stock market your chances are effectively 100%, not guaranteed of course but statistically very high probability.

And please don't give me the spiel about panic selling at a loss and great depression -80% crash etc. I'm talking purely from a statistical prospective, hence why we're working with averages and not specific time periods in the stock market. 

I think premium bonds are fantastic for short periods where you need some ok returns on your money without committing it to something that could lose value in the short term. But I don't see the appeal of using premium bonds as a long term "investment" option.

david29dpo

Good for you
Over the last 4 years my return on PBs has been 7.8%

david29dpo

Do you work for them in some way?

Bostonerimus1

Apples and oranges, one is less risky than the other and one is also tax free. There's room for both products in most people's portfolios. In most cases good financial planning isn't necessarily about trying to maximize return, it's about maximizing the probability of success with the minimum risk.

SneakySpectator

Bostonerimus1 said:

Apples and oranges, one is less risky than the other and one is also tax free. There's room for both products in most people's portfolios. In most cases good financial planning isn't necessarily about trying to maximize return, it's about maximizing the probability of success with the minimum risk.

S&S ISA are also tax free.

masonic

SneakySpectator said:

So if you have £50,000 in premium bonds and left it there for 20 years, the probability of all your collective wins over that period of time amounting to at least £180,000 (£180,000 wins + initial £50,000 initial deposit = £230,000 total) is 60% - 70%. 

But if you invested that £50,000 into a passive index fund like MSCI World Index that averages 7.7% return per year. After 20 years you should expect to have somewhere in the region of £230,000. So with premium bonds your chances are mediocre. While with the stock market your chances are effectively 100%, not guaranteed of course but statistically very high probability.

If the average return is 7.7%, then the chance of achieving it is not "effectively 100%". It implies that the outcome of about 50% of investment periods is lower than this average. So you seem to have unwittingly made the argument that Premium Bonds, with a greater than 50% chance of achieving the MSCI World Index average, would be a better bet, and with none of the tail risks of a nominal loss. I don't know where you've obtained these statistics from, but you might want to check them.

As you've pointed out in a subsequent post, recent returns have been much higher than the long term average. So if you believe in the long term average, this suggests mean reversion and a period of lower returns is to be expected at some point in the future.

Of course the fatal flaw in any of this statistical analysis is that past performance is no guide to the future.

SneakySpectator

masonic said:

SneakySpectator said:

So if you have £50,000 in premium bonds and left it there for 20 years, the probability of all your collective wins over that period of time amounting to at least £180,000 (£180,000 wins + initial £50,000 initial deposit = £230,000 total) is 60% - 70%. 

But if you invested that £50,000 into a passive index fund like MSCI World Index that averages 7.7% return per year. After 20 years you should expect to have somewhere in the region of £230,000. So with premium bonds your chances are mediocre. While with the stock market your chances are effectively 100%, not guaranteed of course but statistically very high probability.

If the average return is 7.7%, then the chance of achieving it is not "effectively 100%". It implies that the outcome of about 50% of investment periods is lower than this average. So you seem to have unwittingly made the argument that Premium Bonds, with a greater than 50% chance of achieving the MSCI World Index average, would be a better bet, and with none of the tail risks of a nominal loss. I don't know where you've obtained these statistics from, but you might want to check them.

As you've pointed out in a subsequent post, recent returns have been much higher than the long term average. So if you believe in the long term average, this suggests mean reversion and a period of lower returns is to be expected at some point in the future.

Of course the fatal flaw in any of this statistical analysis is that past performance is no guide to the future.

I don't follow. If flipping a coin averages at 50% heads or tails. Then over a long period of flips the probability of getting 50% heads and 50% tails becomes very close to 100%.

So if the average return on a index fund is 7.7% then over a long period of time the probability of that 7.7% average being met is very close to 100%.

I think that makes sense? The issue is, is 20 years a long enough time frame? Some say it is others say it's not. Obviously I'd like to see data for 100 years or more but I don't think that data exists. 

And yes past performance is not a guarantee of future returns but it's pretty damn accurate over the long term, or so it seems.

masonic

SneakySpectator said:

I don't follow. If flipping a coin averages at 50% heads or tails. Then over a long period of flips the probability of getting 50% heads and 50% tails becomes very close to 100%.

Incorrect. Suppose you flip a coin 4000 times. The probability of getting exactly 2000 heads is just 1.26%. The probability of fewer than 2000 heads is 49.37% and the probability of greater than 2000 heads is 49.37%. So the probability of achieving at least the average becomes very close to 50%, not 100%. This seems to be the root cause of your misunderstanding.

With investment returns, the standard deviation is quite large, so the range of possible, or even likely, outcomes over a 20 year period might surprise you.

SneakySpectator

masonic said:

SneakySpectator said:

I don't follow. If flipping a coin averages at 50% heads or tails. Then over a long period of flips the probability of getting 50% heads and 50% tails becomes very close to 100%.

Incorrect. Suppose you flip a coin 4000 times. The probability of getting exactly 2000 heads is just 1.26%. The probability of fewer than 2000 heads is 49.37% and the probability of greater than 2000 heads is 49.37%. This seems to be the root cause of your misunderstanding.

With investment returns, the standard deviation is quite large, so the range of possible, or even likely, outcomes over a 20 year period might surprise you.

Yes the probably of getting exactly 2000 heads and 2000 tails is low, but the probably of getting very close to those figures is extremely high.

I just did a simulated coin flip and first try got extremely close to 50% / 50%



I bet you could run this simulator all day and you'd get 50% / 50% give or take 1% either way. So applying that to the 7.7% return for 20 years would give you an expected multiple 5.46x your money. But in reality it's probably somewhere in the region of 4.5x - 6.6x. Getting smack bang on 5.46x would be really unlikely. 

masonic

The probability of getting at least 7.7% is still about 50%, so your stated 60-70% chance of getting that return from Premium Bonds would still make PB the better investment if true.

If you can achieve 7.7% with 60-70% likelihood, the average return must be higher than 7.7%.

SneakySpectator

masonic said:

The probability of getting at least 7.7% is still about 50%, so your stated 60-70% chance of getting that return from Premium Bonds would still make PB the better investment if true.

If you can achieve 7.7% with 60-70% likelihood, the average return must be higher than 7.7%.

Either you're gaslighting me or I just don't get it, sorry.

The probability of the 20 year period averaging out to 7.7% per year is very high, close to 100%

Some years will be +10%, others -8%, others +14% but after a long enough period of time the probability of all those individual years averaging out to 7.7% is very high. If every year was 7.7% for 20 years, your average return would be smack bang on 7.7%. But since each year gives different returns, the probability of getting smack bang on 7.7% is low, but the probability of getting very close to that number is high...

I don't know where you're getting your reasoning from.

Maybe you can use a different example to help me understand?