# Prize Bonds -> Unit Linked Investments?



## MysticX (23 Feb 2012)

Hi all,
I've been considering whether to cash in my Prize Bonds and put the funds into unit linked investments.

I've calculated that my average yearly return on my prize bonds is about ~ 3.0%. (Could be better but not too bad considering normal deposit accounts would have to offer 3.9% to match this).

I don't need the funds for the foreseeable future and thought moving them into an execution only service offering investment funds with a low annual management charge (e.g. 1 - 1.5%) should be something worth considering.

Any thoughts?


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## LDFerguson (24 Feb 2012)

You're not really comparing like with like.  Prize Bonds are arguably not an investment at all but a gamble with a capital return guarantee.  The return you quote on yours is pure luck and completely random.  But in general: - 


By switching from Prize Bonds to a unit-linked fund you are losing the capital guarantee.
By selecting a portfolio of unit-linked funds that match your own appetite for risk, you can influence the likelihood of achieveing a particular return.  For example, by selecting a lower-risk portfolio your potential return is correspondingly lower, but the risk of unexpected events adversely affecting your return is also lower.  Prize Bonds are an all-or-nothing bet over which you have no control whatsoever.


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## MysticX (24 Feb 2012)

Thanks LDFerguson,
It's good to get such a clear viewpoint. I've got a bit more thinking to do but I think I'm leaning towards the unit linked fund path, especially since Prize Bonds are part of the national debt.


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## Brendan Burgess (24 Feb 2012)

> Prize Bonds are arguably not an investment at all but a gamble with a capital return guarantee



For €100 worth of Prize Bonds, this is correct. You may win nothing at all.

However, if you have a substantial number of prize bonds, you will win a number of small prizes, so a return of around 2% would be expected. It might be a bit lower and it could be a lot higher, but it will average out at 2% over time. 

Brendan


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## Marc (25 Feb 2012)

More precisely it will average out over an infinite period of time.

It may not average anything like 2% even with a substantial holding over your lifetime.

The reason for this is that the prize fund is skewed by the large prizes. If you never win a large prize your average will be lower.

If you assume you are not going to be lucky (which is most likely to be the case) then buying prize bonds is a bad idea compared to a standard savings account. 

If you assume that you are going to be lucky then why not just spend a few euro on a ticket for the EuroMillions?


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## SPC100 (2 Mar 2012)

There is no guarantee you will win anything with prize bonds, but there is an expected return based on probability.

According to the last annual report on the prize bond website, they pay out 3% of their holdings as prizes.

About a third of their payout goes on high value prizes which only a very small number of people will win. Leaving 2% remaining as the common prizes.

So excluding the rare large wins, a typical investor/gambler would have an expected return of 2%. 

That said variance could result in a significantly higher or lower actual return.


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## Evander73 (19 Jan 2013)

How do you calculate the probability of winning a prize of any given week e.g.

Total number of prize bond units held by an individual = 2,500
Total number of prize bond units overall = 258,000,000
Total number of prizes awarded each week = 8,500

I calculate odds of 12/1 of winning a single prize of any denomination - is this correct?


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## dub_nerd (20 Jan 2013)

Evander73 said:


> How do you calculate the probability of winning a prize of any given week e.g.
> 
> Total number of prize bond units held by an individual = 2,500
> Total number of prize bond units overall = 258,000,000
> ...


 
That's about right. I looked at this before. Can't remember the exact figures, but the odds on winning the €1m monthly prize were low enough that you could not expect to win it in many lifetimes. But the rest of the prizes are distributed evenly enough that if you have a substantial number of prize bonds (in the thousands) you could expect the return to average out about 2%. Given that 2% net of tax is on a par with the current best six or twelve month term deposits, I've been seriously looking at it lately as a way of generating a return. Plus, you've got a long shot at a more substantial return, although I would not count this as a sensible reason for doing it.


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## Marc (20 Jan 2013)

In all these calculations and assumptions, don't forget that you also need to factor in the impact of inflation.

If your expected return is 2% but you anticipate inflation to average 2.5% then this would translate to a guaranteed loss of purchasing power over time.

How many informed investors making a considered decision would buy an investment that was guaranteed to make them worse off in the future unless they were extremely lucky and happened to win a big prize?
Not many would be my guess.


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## monagt (20 Jan 2013)

> How many people would buy an investment that was guaranteed to make them worse off in the future unless they were extremely lucky and happened to win a big prize?
> Not many would be my guess.



Wrong Marc, many of my friends are flocking to the Post Offices these days on the basis that the tax and PRSIs make the rest of cash deposits bad value.

And when I explain that after 3,4,5 years with inflation they will lose value, they don't seem to care.


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## Evander73 (20 Jan 2013)

Thanks for confirming the logic of my figures.  I reckon you would need a multiple of units, to that in my example, in order to reduce the odds to a respectable level of probability, to make it a viable investment/gamble.  An (albeit not guaranteed) average return of 2%, would be ok at current inflation levels, however I agree the inflation rate would have to be monitored, in order to protect against this insidious enemy. As I'm pretty much risk averse in the current turbulent financial climate, I'm happy (as you can be) that the capital investment is secure!    So, with this in mind, it leaves few alternative 'safe' investment opportunities, apart from deposit accounts.  The best 'On demand' rate is currently 2.75% gross, with the best one year fixed rate 3.06% gross - factor in a 33% DIRT rate and these rates will come in around the 2% anticipated prize bonds return, with no possibility of 'striking it luck' - yes, I know the chances of that happening are extremely remote - but at current deposit rates, I see it as a 'free spin' with an added bit of excitement thrown in for good measure!


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## Marc (20 Jan 2013)

Remember that Ireland is also rated BBB+ by Standard and Poors so you not only have the inflation risk but you also have some default risk that you are not being paid for.

Overall therefore a bad investment decision


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## Marc (20 Jan 2013)

Monagt 

Thanks for the heads up I have edited my post to make my point clear


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## dub_nerd (20 Jan 2013)

Marc said:


> In all these calculations and assumptions, don't forget that you also need to factor in the impact of inflation.
> 
> If your expected return is 2% but you anticipate inflation to average 2.5% then this would translate to a guaranteed loss of purchasing power over time.
> 
> ...


 
I've opened a few deposit accounts lately and every bank has told me that's exactly what people are doing -- foregoing riskier investments for better capital protection, regardless of inflation.

With deposits subject to both DIRT and PRSI from next year, a tax free return of 2% starts to look not too bad.

All that said, I'd be interested to get your opinion on what sort of things informed investors are investing in?


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## Duke of Marmalade (20 Jan 2013)

Marc said:


> Remember that Ireland is also rated BBB+ by Standard and Poors so you not only have the inflation risk but you also have some default risk that you are not being paid for.
> 
> Overall therefore a bad investment decision


The government, unlike private individuals and companies, can, if it defaults, decide who it defaults on. I think Prize Bonds and An Post savings in general are last in the queue.  There's only a few billion there anyway.  If the government can't pay their last 10bn of debt then we surely are witnessing Armageddon.  I rate An Post savings AAAAAAAA+++++++.


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## Marc (20 Jan 2013)

Duke

I hope you are right.

Unfortunately "hope" is not a legitimate strategy when looking after tens of millions of other people's money.
I don't have the luxury of hoping the State won't default.


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## Evander73 (20 Jan 2013)

We live in unprecedented times, so regardless of what product or institution you 'trust' your money to, there is a risk.  However, I feel it is highly unlikely that the Irish legislature would 'burn' citizens who invested in a sovereign Government, who offered a cast iron guarantee of capital security.  As the Duke says above, they can decide on who gets paid in the event of a default.  This being the case, IMO the S&P rating is of more relevance to fund managers, bond holders and large scale international investors in Ireland Inc, rather than the millions of Irish voters investing 'a few bob' in a total pool of 'only' 2-3 billion, where a much higher potential for the return of capital invested could reasonably be expected, certainly higher than BBB+.  

With all that has happened since 2008, my faith in any private investment opportunities is severely shaken, which are similarly exposed to inflation as any other product, not to mention IMO carrying a greater risk of capital depreciation - so because of the above, I'm sticking with State Savings of some shade.  They most likely won't bear large returns, but at the very least should avoid risking losing everything.  The same can't be said for a lot of private investment opportunities, which offer potentially much greater returns, but as recent history has thought us, definitely carry a higher risk e.g. Irish banking shares.


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## dub_nerd (20 Jan 2013)

I think we are unlikely to default without also leaving the eurozone. In that case, even though your State Savings may well be honoured, they may be worth a whole lot less than the euros you bought them with. Be that as it may, I still consider them better than other unacceptably risky investments.


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## Duke of Marmalade (21 Jan 2013)

Marc said:


> Duke
> 
> I hope you are right.
> 
> ...


I would expect someone looking after 10s mill of OPM would look a bit deeper than the one dimensional rating of the agencies.

They should ask what form will default take if it does happen. 

Anything I read or hear from the "professionals" suggests that this will (if it happens at all) take the form of a restructuring. Given the very small financial gain and the huge negative political fall-out I cannot see state savings being restructured.

Another, though IMHO remote, possibility is, as has been mentioned, Euro exit followed by devaluation. Obviously this would hit state savings but no more than any other domestic deposit.

Then there is the possibility that the anarchists get control and Fierce Doherty unilaterally defaults. Whilst unemployment levels remain significantly below 50% it is difficult to see a democratically elected anarchist government. In such a situation we could probably see any state savings above a certain threshold being punished just out of begrudgery. I would say the first 100k is relatively safe from this theft.

Another key aspect not present in wholesale bonds is that if you see any of these eventualities coming you have an exit route in that you can cash in your original investment plus accrued interest.  

Anybody who argues that the BBB+ rating which attaches to the wholesale bond market is equally applicable to state savings is missing the plot.

If I were an IFA, which I am not, my first line of advice is fill your boots with state savings and this is exactly what I have done. But then I wouldn't survive very long - no commissions in that - easier to point to BBB+ ratings and sell the latest fancy investment creation.

_Marc_, you appear to believe that state savings are on a par with promissory notes when it comes to risk of default. I respectfully disagree.


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## Marc (22 Jan 2013)

Duke

It is more subtle than that and I am not making the case against State savings in general here this thread just relates to my position on Prize Bonds. 

Have you heard of Pascal's wager?

French Philosopher who asked the question: given that you cannot prove the existence of god, how should you live you life?

Pascal concluded that the issue was one of downside risk. If God doesn't exist all you lose by acting as if he does is an hour on Sunday. Whereas if he does exist and you act as if he doesn't - then its eternal damnation.

The conclusion therefore is that you should live your life as if God exists even if you don't really believe in God since the downside risk is so great.

Applied to investing a guiding principle of a Fiduciary adviser is that you should never assume that the highly improbable is impossible.

Applied to the question of Prize Bonds, the logic is as follows.

Do we know for sure what will happen? Answer no
Do we know for sure that there is a risk here? Answer yes, the State cannot possibly meet it's obligations in full if required to do so. Then ELG if called upon simply cannot be met in full. We know this for absolute certain. Therefore in the unlikely but not impossible event of a default, as you correctly conclude the State will be required to decide who is going to get how much. This is a lottery and the results cannot be known in advance by anyone.
But, the State is independently rated as BBB+ , therefore independently assessed, more secure alternatives are available in the market. I do not have to accept this risk if I don't want to. I have choices here
Am I being paid for this risk? Answer, no. I am not being compensated in the interest rate for the risk of default however unlikely this may be
Are alternatives available? Answer yes. I can invest in more diversified higher credit rated options and not reduce my expected return after costs and tax. In principle I can therefore take less risk and get the same or even potentially higher expected return, following the principle of Pareto optimality I therefore *must* do something else as to do otherwise is irrational and from my perspective as an adviser irresponsible. Remember that private individuals are only responsible to themselves for their own actions.
It therefore possibly even follows that my legal duty of care to my clients would probably require me to advise against Prize Bonds. There is even precedent here since when the State introduced Sovereign annuities they first introduced legislation to prevent advisers being sued by their clients if the State defaults. 
So what should I do? Something else! The downside risk, however unlikely and regardless of what you or I might personally think or hope would happen is irrelevant. I am not being paid for either the inflation risk or the default risk in Prize Bonds, they are therefore a relatively bad investment.


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## dub_nerd (22 Jan 2013)

That independent BBB+ rating is from Fitch, right? That'd be the same Fitch who upgraded Anglo Irish Bank from A to A+ in late 2006 citing increased diversification of assets and funding when, in fact, Anglo were almost exclusively up to their necks in property during the soon-to-burst greatest property bubble in history? I don't think I'd be relying on the diagnostic power of agency ratings when choosing an investment.


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## Duke of Marmalade (22 Jan 2013)

_Marc_ as I said I am fairly up to my neck in state savings.  However, I didn't go for the PBs.  I thought about it hard, but in the end of the day the chances of the big wins are very remote even for a large holding.

Nothing is 100% safe.  State savings with their politically protected status and early exit facilities are about as safe as there is - even safer than German bonds, certainly safer than gold and most definitely not BBB+.


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## monagt (22 Jan 2013)

> According to Moneyfacts there are only three Isa products that negate the effect of inflation, and once taxpayers have used these there is no risk-free way of stopping cash being eroded by inflation.
> The effects of inflation can be significant. £10,000 invested five years ago, allowing for average interest and tax, would be equivalent to £9,016 today.



Was it Buffet who said cash deposits were the worst investment of all??


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## dub_nerd (22 Jan 2013)

> According to Moneyfacts there are only three Isa products that negate the effect of inflation, and once taxpayers have used these there is no risk-free way of stopping cash being eroded by inflation.
> The effects of inflation can be significant. £10,000 invested five years ago, allowing for average interest and tax, would be equivalent to £9,016 today.


 
But that's a UK website, right? And interest rates have been lower, and inflation higher, in the UK compared to here. Here you would have got 21% return (3.53% APR tax free) from a 5½ year Saving Cert, or 5%+ AER gross from a bank over the same period, and inflation was probably negative for some of it. Apples and oranges.


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## leroy67 (22 Jan 2013)

You can't compare unit linked investments with prize bonds, apples and oranges, prize bonds are for depositors like state savings, unit linked funds invest in different asset classes with a higher risk profile. anyone in a low risk or capital guaranteed unit linked fund shouldn't be there as management charges probably outstrip growth potential


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## Duke of Marmalade (23 Jan 2013)

Duke of Marmalade said:


> State savings ...are certainly safer than gold...


That felt a strange thing to say at the time. After all the perception is that nothing is safer than gold. In one sense that is true - gold is the asset which is least likely to lose *all* its value. But that very property conveys to it an Armageddon insurance status especially for the super rich with a result that its price and therefore its current value becomes high risk.


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## Palerider (28 Mar 2013)

I had €100k in prize bonds until before Christmas when I cashed in and went into the 3 year State Savings before the rate reduced, I did well with the prize bonds and almost matched what the best deposit account paid allowing for DIRT.

With deposit rates now much less than before I went back to my prize bond spreadsheet and recalculated my returns based on the current best deposit rate available, I would be up about €600 on that over the 27 months I was in PB's.

So I am going back into PB's, current deposit rates, DIRT , PRSI coming etc is encouraging me, the fact this is near cash appeals also, I got my funds last time within a week of surrendering the bonds so unless all hell breaks loose I should be able to access this cash quickly and of course they are a first obligation of the Government.

What are the views now post Cyprus, am I considered nuts..?


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## camlin90 (28 Mar 2013)

First of all, you should note that the Prize Bonds interest rate fell from 3% to 2.25% in December.

Stripping out the jackpot prize which is pretty much impossible to win, this means the expected return is now around 1.5%.


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