The Full English Accompaniment – Premium Bonds: The time is now?

One of the cardinal rules of financial security is to have an emergency fund. If you need to ask why, you’re in the wrong place, and I suggest you read Monevator’s excellent explanation (1). A big credit line isn’t enough. You need 3-6 six months of expenses in a liquid, easily-accessed account. For the basic rules and steps Monevator again has your back (2).

So far, so basic.

Beyond that the arguments start. What classifies as an emergency? How much is too much? Where do you put it?

High yield current accounts and instant-access savings accounts have long been the go-to. Which was fine when returns were 3% plus in the early noughties, but over the past decade interest rates on savings accounts have drifted down (3, 4). The best easy access accounts, including the once-vaunted Marcus, are now returning 1.3% (5). Meanwhile inflation hovers around the 1.3-1.5% mark (6).

So we’re left with a dilemma: do we accept our emergency fund will (at best) tread water or (at worst) lose money relative to inflation, or do we chase returns?

The latter has led to some very creative accounting by some authors, including the suggestion that your emergency fund spending should be built into your household budget (7). Which sort of suggests it’s predictable, and not an unforseen emergency.

Or you could be like a number of other FIRE bloggers (Early Retirement Now, Physician on FIRE), and go without an emergency fund, relying instead on lines of credit and your investments to bail you out (8, 9). This reduces your opportunity cost and improves your returns (10). It also tackles the behavioural problem with an emergency fund; the temptation to dip into it for that emergency TV or holiday. It’s much harder to impulse spend an investment. But do you risk crystallising losses during the inevitable downturn?

Step forward premium bonds; long-derided though the UK’s biggest savings product (11). They’re a psychological leap from an instant access savings account, yet improvements in IT means you can check results on your phone and transfer into cash within a couple of days (ticking that liquidity box) (12, 13). The prize rate has been cut, but it’s still 1.3% – the same as instant access savings (14). And given you’re reading this and into FIRE, you’re probably a higher rate tax payer. Here premium bonds sweeten the deal further, with no tax to pay on winnings (15).

You’re still not likely to see a win, as that 1.3% is practically lower due to the skewing effects on the average of the top prizes. But maybe now, in the days of rubbish cash returns, premium bonds offer a credible emergency fund safe haven.

Have a great week,

The Shrink

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P.S. Couldn’t really get away without mentioning the Coronavirus outbreak could I? I’ve briefly mentioned my thoughts in the Reasons to be cheerful/fearful post, and for how I think it’s going to go see Scenario 5 of the Thought Experiment. Ultimately it’s going to be a difficult time for the markets. Due to the number of unknowns we’re dealing with, trying to price in predictions is near impossible. The efficient market is going to struggle with the level of uncertainty. We’ve been near a market top for a long time. No-one knows the future. Stick with your plan and be confident in your preparation.

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Other News:

Covid-19 mini-special:

Graph shows the exponential and dangerous growth of corona virus compared to other major viruses such as Ebola and SARS.#Corona #CoronaVirus #CoronaOutbreak #ChinaVirus pic.twitter.com/QOco1JQDf5
— Farhang F. Namdar (@FarhangNamdar) February 20, 2020

Wellcome director Jeremy Farrar warns #COVID19 could rival 2008 financial crash in terms of economic damage

'The possible impact of this coronavirus is far beyond a health emergency – it’s a global crisis with potential to reach the scale of the global financial crisis of 2008'
— Andrew Gregory (@andrewgregory) February 27, 2020

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