£40K in Premium Bonds!

[AJC5001]

I recently received an increase in my state pension, thanks to kind Mr Brown’s triple lock, which no politician dare abolish for fear of upsetting us wrinklies.

Unfortunately you seem to have a small memory problem That 'kind Mr Brown' was actually the even kinder Mr Cameron and Mr Osborne as part of the 2010 Coalition Government. Mr Brown only linked to the higher of 2.5% or inflation. See https://researchbriefings.files.parliament.uk/documents/CBP-7812/CBP-7812.pdf for full details.

Adrian

[vrdiver]

Here's a small test to help understand how risk-averse a person is:

I have a coin. It's a fair coin, and the chances of it landing either heads or tails are exactly 50:50.

I will give you £1,000 if it lands heads, but if it lands tails, you will give me £1,000.

No deal? OK...

I will give you £1,500 if it lands heads, but if it lands tails, you will give me £1,000.

Still no deal? How about...

I will give you £2,000 if it lands heads, but if it lands tails, you will give me £1,000.

Oh, I forgot to mention, we can repeat this as often as you want / have funds to play.


Since it's a fair coin, somebody pretty tolerant towards risk might be tempted to go with the first offer, but anybody whose slightly risk averse would probably decline. Any of the subsequent offers, if played a large number of times, would be a positive outcome for the player, but they might still reject the game, depending on their attitude to risk AND their view on the impact of an unlucky streak.

If the impact of loss is significant, none of the above would be acceptable, but if the loss was OK, then which offer they take is a reflection of their tolerance for risk (or their ability to negotiate, once they've spotted the pattern of increasing offers )

In the OP's case, they have £40K so could play 40 tosses of the coin before going bust. It would be interesting to see if they would commit to 40 flips, or whether they'd set a lower limit, which, whilst more likely to go bust (a shorter run of bad luck being more probable than a longer run) would indicate their views on the balance between risk/reward and capital preservation.

Nb. This is a thought experiment, not a KYC process!

VRD

[XFool]

Here's a small test to help understand how risk-averse a person is:

I have a coin. It's a fair coin, and the chances of it landing either heads or tails are exactly 50:50.

I will give you £1,000 if it lands heads, but if it lands tails, you will give me £1,000.

No deal? OK...

Oh no! It's not one of those, they always do my head in. I have never really come to terms with 'subjective probability' etc. Objective OK, subjective? No thanks.

I will give you £1,500 if it lands heads, but if it lands tails, you will give me £1,000.

Still no deal? How about...

I will give you £2,000 if it lands heads, but if it lands tails, you will give me £1,000.

Oh, I forgot to mention, we can repeat this as often as you want / have funds to play.

Now there's my problem straight away.

If this was a one off that would be one thing but, as explained it makes little or no sense to me. Assuming it IS a fair coin (how do we know?) then anything apart from your original £1000/£1000 is worth playing long term. £1001/£1000 would be statistically worth playing - if you, I mean I, had enough cash and I believed you would always offer another go. In practise most would need more than that, so £1500/£1000 would start things off. But whyever would you offer such an obvious opportunity? You wouldn't and, provided I have the cash, I'd be a fool to turn you down - unless I suspected a catch which, in reality I would. If it was genuine I don't readily see how it can be used to easily assess risk-averseness.

But, if a one off, that changes everything AFAIAC. (Subjective Probability says is doesn't - I think)

Since it's a fair coin, somebody pretty tolerant towards risk might be tempted to go with the first offer, but anybody whose slightly risk averse would probably decline.

Why? I disagree - unless it was a one off or a known fixed number. Surely, if unlimited in the number of offers, it makes no sense? Who determines whether a game is on, me or you?

Any of the subsequent offers, if played a large number of times, would be a positive outcome for the player, but they might still reject the game, depending on their attitude to risk AND their view on the impact of an unlucky streak.

If the impact of loss is significant, none of the above would be acceptable, but if the loss was OK, then which offer they take is a reflection of their tolerance for risk (or their ability to negotiate, once they've spotted the pattern of increasing offers )

In the OP's case, they have £40K so could play 40 tosses of the coin before going bust. It would be interesting to see if they would commit to 40 flips, or whether they'd set a lower limit, which, whilst more likely to go bust (a shorter run of bad luck being more probable than a longer run) would indicate their views on the balance between risk/reward and capital preservation.

Nb. This is a thought experiment, not a KYC process!

I don't think this one readily maps to Premium Bonds, because you don't lose your stake (I know, inflation!). Makes more sense with the Lottery?

[Alaric]

If they were to put the lot in an ETF or an IT, the dividends would likely exceed the prizes they are getting from Premium Bonds. Depending on how badly they wanted to be able to lay their hands on the whole or some of the £ 40,000 at short notice, they would find with the stock market investment that every so often its value would be below £40,000. Can they can turn a blind eye to this and appreciate the higher dividends?

[Muddywaters]

On the whole coin toss discussion. Bit off topic but I wrote a bespoke risk questionnaire with one of the main players in this space and we looked at the whole ‘roll a dice’ game theory to see whether it simplified things in the mind of the average bloke on the street (not the average poster here). I also spent hours and hours pouring over regulatory reports and locked in rooms with investment managers/marketing/directors/academics looking at the wording and the methodology of risk profiling questions and it is an absolute minefield. Easily the most difficult and subjective thing I’ve done thus far and I’m still not convinced with what we ended up with.

In terms of Martin Lewis whilst I respect the chap as a businessman, he’s just that a businessman with a pretty cut throat commercial position. A good portion of what he talks is bollovks but he says it with conviction and people love it, but be careful of taking what he says as gospel.

Back on topic. Risk averse investors, no experience, late ish middle age, no need for any growth, no experience, late cycle. Screams premium bonds. Leave as is

[torata]

Here's a small test to help understand how risk-averse a person is:

I have a coin. It's a fair coin, and the chances of it landing either heads or tails are exactly 50:50.

I will give you £1,000 if it lands heads, but if it lands tails, you will give me £1,000.

No deal? OK...

Oh no! It's not one of those, they always do my head in. I have never really come to terms with 'subjective probability' etc. Objective OK, subjective? No thanks.

vrdriver's nicely worded thought experiment is referring to loss aversion, where loss is in general felt twice as strongly as gain. And as he implies, we don't know what their level of loss aversion is.

If it was genuine I don't readily see how it can be used to easily assess risk-averseness.

Actually it can and the experiments have been done. Kahneman got a Nobel Prize for it

torata

[pyad]

I don't think this one readily maps to Premium Bonds, because you don't lose your stake (I know, inflation!). Makes more sense with the Lottery?

I've heard this absolute fallacy repeatedly over the years, The stake on PBs is not the capital, that is simply an instant access loan to the government.

The stake paid by players to participate in the draw is the interest foregone on that capital, not the capital itself. I would have thought that much is obvious but it is very surprising how often the "can't lose your stake" falsehood is repeated and believed by many.

[BusyBumbleBee]

Good to see you over on this board, PYAD. And good to see you as robust as ever. But why did you wander over from the HYP board ? where I see 95% of your posts are. Most amused to see that your most active topic is "LandSex HYP1 forthcoming change"
Is it just that the "C" is next to the "X" on the qwerty keyboard or is there something else here ?

with kind regards - BBB

[XFool]

I don't think this one readily maps to Premium Bonds, because you don't lose your stake (I know, inflation!). Makes more sense with the Lottery?

I've heard this absolute fallacy repeatedly over the years, The stake on PBs is not the capital, that is simply an instant access loan to the government.

The stake paid by players to participate in the draw is the interest foregone on that capital, not the capital itself. I would have thought that much is obvious but it is very surprising how often the "can't lose your stake" falsehood is repeated and believed by many.

You've lost me on this, pyad.

The "stake" AFAIAC, and most people I would think, is the money you enter in the draw. With PBs this stake is always there to be paid back. [Here I ignore inflation. Also, if you ever were to be refused payment, then the situation in the nation would be so dire that all bets would be off.]

The interest on that capital is NOT "forgone on that capital", except in the case of a low holding in PBs. It is how it is distributed - to the individual bondholders - that is the gamble. And the whole point of my previous comments on PBs was about holding enough so they could be compared to a typical interest bearing bank account. Obviously there are some existing bank accounts that will pay a bit more. I also made the point that PB winnings are completely outside the income tax regime.

But, if you can point us at any alternate current UK government backed bonds, gilts etc. yielding say ~5% (without risk of capital loss), I'm sure we will be all ears.

[XFool]

vrdriver's nicely worded thought experiment is referring to loss aversion, where loss is in general felt twice as strongly as gain. And as he implies, we don't know what their level of loss aversion is.

If it was genuine I don't readily see how it can be used to easily assess risk-averseness.

Actually it can and the experiments have been done. Kahneman got a Nobel Prize for it

Yeah. I know that. But was the example given a true and appropriate version and was it applicable in the case of the OP? Offhand I don't know (I'd have to go away and refresh my memory) but I didn't see how it was. To me, a one off version of the bet seemed a more graspable version.

[XFool]

Back on topic. Risk averse investors, no experience, late ish middle age, no need for any growth, no experience, late cycle. Screams premium bonds. Leave as is

Although I didn't offer any advice, I too was rather inclined to that view.

The trouble is, as I see it, we have little or no background information - just late 60s, £40,000 in Premium Bonds - to actually suggest any really sensible advice. We don't know:

If married or single
If children or not
State of health
Any other income
Any other capital
Outgoings
Habits
Tax bracket
Attitude to 'risk'
...

Of course, if you ask for advice on TLF, it is going to be: "Put it into the stock market". It's a bit like wandering into an estate agent and asking: "Should I buy a property?"

[swill453]

Of course, if you ask for advice on TLF, it is going to be: "Put it into the stock market".

That statement proven wrong by at least half the answers on this thread.

Scott.

[XFool]

Of course, if you ask for advice on TLF, it is going to be: "Put it into the stock market".

That statement proven wrong by at least half the answers on this thread.

Reviewing the advice, I'm glad to say: I think you're right.

Mea culpa. And long live TLF, a good place to come for sensible advice!

[pyad]

You've lost me on this, pyad.

The "stake" AFAIAC, and most people I would think, is the money you enter in the draw. With PBs this stake is always there to be paid back. [Here I ignore inflation. Also, if you ever were to be refused payment, then the situation in the nation would be so dire that all bets would be off...

If I've lost you, that's pretty sad because it's very simple. The "stake" is not there to be paid back. You cannot get it back, ever. What you can get back is the capital which as I said is nothing more than a loan to the government, which is repayable but that is not the stake. You are completely wrong to describe the invested capital as the "stake" and if "most people" do the same then they are equally wrong too. I agree it's a common misconception, that was my very point, but since when does a misconception being common make it correct?

The meaning of "stake" in gambling is the amount you place at risk in order to try and win. With PBs the amount you place at risk is not the capital but the interest that you don't receive, thus that interest is foregone, in plain English you just don't get any. We all know that the prize fund comprises the interest paid by the government but that's in total. At the individual level, which was what is being discussed here, you don't get any interest and instead, you forgo it in return for the gamble.

I have nothing against PBs by the way, I just don't like the common, yet totally wrong, idea that you "can't lose your stake" when you obviously do. Why not just admit you were wrong?

[XFool]

You've lost me on this, pyad.

The "stake" AFAIAC, and most people I would think, is the money you enter in the draw. With PBs this stake is always there to be paid back. [Here I ignore inflation. Also, if you ever were to be refused payment, then the situation in the nation would be so dire that all bets would be off...

If I've lost you, that's pretty sad because it's very simple. The "stake" is not there to be paid back. You cannot get it back, ever. What you can get back is the capital which as I said is nothing more than a loan to the government, which is repayable but that is not the stake. You are completely wrong to describe the invested capital as the "stake" and if "most people" do the same then they are equally wrong too. I agree it's a common misconception, that was my very point, but since when does a misconception being common make it correct?

The meaning of "stake" in gambling is the amount you place at risk in order to try and win. With PBs the amount you place at risk is not the capital but the interest that you don't receive, thus that interest is foregone, in plain English you just don't get any.

OK. I'm with you with the correct definition of "the stake" in gambling. It is an interesting point, which has never occurred to me before. However...

We all know that the prize fund comprises the interest paid by the government but that's in total. At the individual level, which was what is being discussed here, you don't get any interest and instead, you forgo it in return for the gamble.

Yeah. BUT, if you hold a sufficient number of bonds you DO indeed get a reasonably predictable (if lumpy) slice of that Bond fund interest. The only question is: How does it compare to a normal interest bearing account?

I have nothing against PBs by the way, I just don't like the common, yet totally wrong, idea that you "can't lose your stake" when you obviously do. Why not just admit you were wrong?

Agreed wrt the precise definition of "stake", but not with the all sweeping "you don't get any interest". Unless you are using some strict definition of "interest" - such as that "interest" has to be paid at regular and predictable intervals. In which case perhaps we could settle on 'interest'?

Anyway, we can surely still compare annual PB winnings to an interest bearing account? We aren't going to lose our shirt!

[BusyBumbleBee]

The "stake" AFAIAC, and most people I would think, is the money you enter in the draw. With PBs this stake is always there to be paid back.

The point PYAD is making is that it is the interest foregone that is your stake not the bond itself which is not at risk at all. He is absolutely right.

[XFool]

The "stake" AFAIAC, and most people I would think, is the money you enter in the draw. With PBs this stake is always there to be paid back.

The point PYAD is making is that it is the interest foregone that is your stakenot the bond itself which is not at risk at all. He is absolutely right.

I get that!

I just made the mistake of saving my draft(TLF is on a go slow again) in an attempt to clarify my previous reply to pyad. Should have saved it to Notebook.
Risk assessment, huh!

Rather than trying all over again I'll reply here:

You expect to lose some of your stake. But, with a sufficient number of bonds, you expect to win too in a year. So you certainly don't lose all your stake. What you expect to lose is the difference between the real Bond Fund interest (currently 1.4%) and your actual winnings in a year - for comparison with what you will get from a normal interest bearing account. This seems to me to be the basis of comparison.

You could of course compare Premium Bonds to other government backed loans, bonds or Gilts. Here, advantages of PBs to consider are wrt income tax and no risk of capital loss.

[mbdmbd]

I am a fan of Premium bonds. They are basically the lowest risk investment I'm aware of. I think that we all recognise that they pay back (on average) less than inflation - but so do many safe investments.

I believe that NS&I are paying 1.4% to the prize fund, which statistically gives your relatives an 'expectation of 1.4% gain', in terms of probability. Unfortunately a lot of the 1.4% is piled together into the big prizes - and if you don't win one of those you get a lower return than 1.4%.

If you want to keep 100% security and beat 1.4% you could point them at UK banking-guaranteed cash ISAs at (currently) about 1.9% for 2 years. Again not inflation beating - but they are 100% safe. The tax free status may or may not be of interest to them, and slightly higher rates can be found for cash savings if tax isn't an issue - but ISAs are nice and simple and you can always buy the premium bonds back after 2 years if they are an unwelcome administrative chore.

The only risk to consider is that the interest rate could rise and make 1.9 look like a bad deal. With brexit cooling economic growth for the foreseeable future I will be shocked if there is a significant and sustained increase in interest rates in the next 12-18 months.

mbdmbd: 7th April 2019

[Itsallaguess]

How about a bit in P2P / Ratesetter , in an IFISA

Riskier than cash but (probably) much safer than equities [no FSCS guarantee of course]

I've got to be honest - I'd not countenance any that as being appropriate for this situation.

Regarding my resistance to the above P2P suggestion, I'd hope that no-one has missed this very interesting thread over on the 'Other Investing' board, which is discussing P2P, and what seems to be a real difficulty with some people being able to actually access their cash from some P2P platforms, when required to do so -

https://www.lemonfool.co.uk/viewtopic.php?f=78&t=4984&start=60

These two quotes in particular stand out -

(i) I decided to withdraw from p2p 5 months ago. Getting out of FC was quick (bar the muddle of loans in recovery mentioned above), but much slower from other providers. I've only managed to get 50% out so far, and I suspect it will be years for the rest, and I expect substantial capital losses.

(ii) No-one has been able to get money out of Lendy this calendar year, other than interest payments, and a handful of loan repayments. Nearly all loans are overdue and not tradeable, or have a near infinite time to sale on the secondary market.

Scary stuff - and good luck with explaining those situations to elderly relatives that you might have advised regarding moving their rainy-day Premium Bond capital into P2P....

Cheers,

Itsallaguess

[AleisterCrowley]

I wouldn't 'advise' anyone to invest in P2P, but it's worthy of a mention when people are talking about ITs/ETFs etc as a small part of a portfolio
RateSetter have a pretty good reputation and there have been no issues so far...
I reckon about 4% of my portfolio is in RateSetter, I certainly wouldn't go above 5%