Probability: why Premium Bonds may not pay off

Published on May 6, 2016

Premium bonds are popular but this week Tim Bennett looks at why investors may end up being disappointed with their returns.

0:11welcome to this week’s killing explains finance video the topic this week why

0:16investors must have a basic grasp of probability of why if they don’t they

0:21might be wrong investment choices are made using premium bones have their

0:25place to demonstrate what I mean so what is the problem

0:30well did you know problem number one back if you flip a coin nine times and

0:35get heads the probability of getting ahead on the 10th row is 259 words these

0:41discrete results ok more complicated one here it is

0:46told there is a pride by one of three goals and nothing behind the other two

0:51so you pay 2001 your host says right I’m opening door three and telling you

1:00there’s no prize behind it

1:02you want to stick or move to door to you might be thinking it’s a fifty fifty

1:07cool I’ll stick with door one actually because you’ve now got extra information

1:12from your host

1:14that’s no longer true reasons I can explain outside the scope of this video

1:18if you moved or two of two winning increased to 20 the Monty Hall problem

1:25now why is that relevant

1:27well in a nutshell because with a product like premium bones to some

1:33extent the government’s relying on a fully understand probabilities or use

1:38this product to demonstrate why so what’s the deal what’s on offer

1:42well this is a government-backed product the national savings investment website

1:46says Happy Days you buy premium bones because you were looking winning a

1:51tax-free prize between 25 pounds on a prize draw basis and 1,000,000

1:57happens every month sounds too good to be true and has taken that does draw a

2:02lot of people in so here’s a minimum investment 100 pounds maximum premium

2:07owns fifty thousand pounds quite a range of investments that the monkey prize

2:11draw is done by computer web site you can tap into one or not

2:17tax free prizes do indeed range 25 pounds up to a million but I explain how

2:21in just a moment and all things backed by the government and they play on that

2:25and the selling point is effectively a risk-free investment so there is a

2:30nuts-and-bolts now as a result that is the UK’s biggest savings product having

2:37attracted to date around sixty billion of investment but there isn’t catches

2:42now what to expect

2:45websites right this prize system means on average you’ll make around 1.35

2:51percent tax free as an investor in premium bones thats dropping 1.25% June

2:572016 sounds pretty good when you think about the rates available on savings

3:02accounts but there is a can lose money saving expert points out actually the

3:08reality is thanks to probability you are likely to get a lot less than 1.35 or

3:151.25% and your chances of winning the top headline prize but million pretty

3:20minuscule now why not challenge because the prize distribution is heavily skewed

3:26and the bottom an 8.1 most of the prizes are 25 pounds only a handful of fifty

3:34pounds and a tiny number your number are above that level so that’s point number

3:40one point number two is it’s all or nothing you either win a prize

3:45we had our chances are you won’t so imagine for example with a hundred

3:49pounds in this year after June your thinking on an interest rate of 1.25%

3:54tax-free maybe not because reality is when the prize draw your gonna get

4:00nothing

4:01ng or 25 pounds is nothing in between and the reality is at a rate of 1.25% if

4:08you’ve got twenty people all investing a hundred pounds as 2,000 pounds in total

4:121.25% is 25 pounds by any one person’s probably gonna win a prize in nineteen

4:19people go and handed had one person happy days

4:2325 pound prize that’s where probability matters when you’re trying to understand

4:28this headline right now what about bigger some 4,000 pounds in and most

4:35people will still win

4:37absolutely nothing reality and 2000 which is the maximum jackpot chances of

4:45winning a million pounds are only around 140 9000 drawl makes it slightly less

4:52likely you could argue then winning lottery question then is what people

4:58think is better than that white people winning without one of the reasons is

5:03that people tend to talk about winning not losing so you’ve heard someone get a

5:08prize you know someone has won a prize that might be enough to bring you a and

5:12secondly we like the idea of a free lunch we like the idea we could with a

5:16medium and we tend to discount their brains the fact that it’s highly

5:19probable inclusion am I just missing premium on the other hand no because the

5:28possibility you might get round 1.35% 1.25 percent from June is attractive tax

5:34rates whose son taxpayers to some investors hireright ticular I’m not

5:38going to deny that is government-backed and it’s been more exciting than the

5:41standard savings product but on the flip side whether or not you achieve a

5:46published writer and a true some complex probability don’t assume you’re gonna

5:51get 1.35 1.25 percent cash account and investment accounts aback by the

5:56Financial Services Compensation Scheme anyway so this government pledged to

6:00back premium bonds isn’t worth quite as much as you might think and your odds of