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

Gers

Grief - not another thread which provokes the ongoing, and frankly boring, same old arguments. 

InvesterJones

OP, you don't mention what your objectives and financial situation are. Perhaps if you could tell us more about your situation we could help better? Generalising or making assumptions that everyone is in the same situation leads to unhelpful conclusions.

OldScientist

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.

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.

I'm not sure that your calculation for PBs is correct. Assuming compounding (which with the maximum amount you cannot) with the 'headline' rate of 3.8%, after 20 years the amount would be £105k (50k*1.038^20), using the median return on an annual holding (3.3%), it would be £96k. In other words, the probability of winning £180k over a 20 year period is much smaller than 60-70%.

So your conclusion is correct as far as it goes that, historically, on average over a 20 year period holding PB will produce less return than holding an equity index.

Assuming a fixed prize rate (i.e., interest rates do not change), the annual volatility (standard deviation) on PB returns is about 1% (the median is 3.3%, the 16th and 84th percentiles are 2.5% and 4.4%, respectively), which is much less than the historic 20% volatility on equities. Of course, volatility in returns due to changes in interest rates are greater, roughly 3% if it is the same as 3-month bills, so the overall volatility will be a higher (simply adding the two sources of volatility together would give 4%).

It is the lower volatility of fixed income (which sort of includes PB) compared to equities that can be useful for some investors.

masonic

SneakySpectator said:

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?

I'm not gaslighting. You are fundamentally misunderstanding the nature of investment returns and probability. When the standard deviation is large, there is a large dispersion around the average.

Take this cFireSim simulation for 100% equities over 20 years using historical data: https://www.cfiresim.com/9bdf7cc4-f995-437e-9c24-b3fe4d5a27eb

This is in USD, but we'll have to live with that. I have set inflation to zero. Starting with $50,000, the median return (the minimum outcome for 50% of 20 year periods) is $183k - close to your average figure, but look at the dispersion: 10% of periods ended with $84k, the standard deviation is $111k.

The probability of getting at least the median return is around 50% - fully half of all 20 year periods in the 100 years of historical data ended in a return less than this, a fair number achieving meaningfully less. You would have a 90% chance of achieving at least a 2.6% return based on this historical data, and only a 50% chance of achieving at least 6.7%.

SneakySpectator

masonic said:

SneakySpectator said:

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?

I'm not gaslighting. You are fundamentally misunderstanding the nature of investment returns and probability. When the standard deviation is large, there is a large dispersion around the average.

Take this cFireSim simulation for 100% equities over 20 years using historical data: https://www.cfiresim.com/9bdf7cc4-f995-437e-9c24-b3fe4d5a27eb

This is in USD, but we'll have to live with that. I have set inflation to zero. Starting with $50,000, the median return (the minimum outcome for 50% of 20 year periods) is $183k - close to your average figure, but look at the dispersion: 10% of periods ended with $84k, the standard deviation is $111k.

The probability of getting at least the median return is around 50%, with a fair likelihood of achieving meaningfully less. You would have a 90% chance of achieving at least a 2.6% return based on this historical data, and only a 50% chance of achieving at least 6.7%.

I still don't understand but I do believe you. So hypothetically if I were to try and plan for the future and say I'm going to invest in an index fund that has historically returned on average 7.7% per year. What percentage annual return should I actually put in the interest rate section on this calculator? 

aroominyork

SneakySpectator said:

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.

That's because PBs are not an investment option, either with or without inverted commas. They are a savings option.

Pollycat

SneakySpectator said:

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.

If it doesn't appeal to you, find a different investment that does appeal.

boingy

SneakySpectator said:

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. 

Premium bonds are terrible for short periods. You are not in the draw for at least a month when you buy them. But they are a 100% safe savings product, unlike Index trackers.

Is there a point to this thread? You are comparing two completely different things. Are you sponsored by someone to promote index trackers? Why stop there? Why not pick tech stocks, or bitcoin, or the South Sea Company?

masonic

SneakySpectator said:

masonic said:

SneakySpectator said:

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?

I'm not gaslighting. You are fundamentally misunderstanding the nature of investment returns and probability. When the standard deviation is large, there is a large dispersion around the average.

Take this cFireSim simulation for 100% equities over 20 years using historical data: https://www.cfiresim.com/9bdf7cc4-f995-437e-9c24-b3fe4d5a27eb

This is in USD, but we'll have to live with that. I have set inflation to zero. Starting with $50,000, the median return (the minimum outcome for 50% of 20 year periods) is $183k - close to your average figure, but look at the dispersion: 10% of periods ended with $84k, the standard deviation is $111k.

The probability of getting at least the median return is around 50%, with a fair likelihood of achieving meaningfully less. You would have a 90% chance of achieving at least a 2.6% return based on this historical data, and only a 50% chance of achieving at least 6.7%.

I still don't understand but I do believe you. So hypothetically if I were to try and plan for the future and say I'm going to invest in an index fund that has historically returned on average 7.7% per year. What percentage annual return should I actually put in the interest rate section on this calculator? 

It doesn't normally make sense to use a figure that you only have a 50:50 chance of achieving, but equally, using a worst case scenario would be overly pessimistic. A common compromise is to use the lower quartile or quintile to give a return achieved in 75-80% of cases. It is then fairly unlikely you will be worse off than this. This would be in the ballpark of half the mean return for 100% equities, given the high dispersion around the mean.

But a compound interest calculator is not the right tool for predicting investment returns. Better to backtest and/or use Monte Carlo analysis. This is because the sequence of returns makes a big difference. Even then, it needs to be taken with a large pinch of salt.

[Deleted User]

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.

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.

Thanks for that.........