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March 04 newsletter

Welcome to the Shape of Money's March 04 newsletter and our discussion on bonus bonds.

Current branding has bonus bonds "turning investment into excitement". But are bonus bonds really an investment? The simple answer is that "yes", bonus bonds are an investment.

Bonus Bonds are an investment in a unit trust. Actually, it's New Zealand's largest unit trust. And like other unit trusts,

• The trust manager will try and get a good return for the investor,
• The trust manager will try and protect your capital, and
• The investment comes with a prospectus (however, it doesn't come with an investment statement).

Like cash unit trusts, there are no entry and exit fees, and you are likely to get out what you put in, dollar for dollar.

But, that is where the similarity with other unit trusts end. While the returns from normal unit trusts are distributed based on the proportion of units, this is not the case with bonus bonds. The returns are instead distributed by way of a prize draw.

So, if you don't get a return, what are the odds of winning a prize? According to their brochure, bonus bonds offer the chance to win over $5m in cash prizes and over 150,000 separate prizes each month.

Or, to be exact, the March 2004 draw distributed the following prizes:

• $300,000 - 1 prize
• $100,000 - 1
• $50,000 - 1
• $5,000 - 54 prizes
• $1,000 - 162
• $500 - 278
• $100 - 2,186
• $50 - 14,416
• $20 - 198,484 prizes

That's a total of $5,930,080 in prize money with 215,583 separate prizes. The value of the average prize was $27.51- a good month.

But, back to the odds of winning. According to the bonus bonds website "the chances of winning a prize are approximately no less than 1 in 9,600".

So if you invest $9,600, you will on average win $27.51 each month. That equates to an annual after-tax return of 3.44%.

It's not a bad return, except that it's the AVERAGE return. Because of the volatility of return, which ranges between zero and $300,000, we believe that bonus bonds really need to pay a much higher return to be classified as an investment, rather than a gamble.

There is no doubt, however, that it's a better gamble than lotto and the TAB, because you are unlikely to lose your capital.

ANZ, who run this investment, are very careful with your money. It's invested safely (and simply) in assets such as government and bank bonds. But, if their investing strategy is so simple how does the ANZ justify the $27 million management fee that they earn each year (Sunday Star-Times, 9 Jun 02, page E7)? Maybe that's what they actually mean when they talk about "turning investment into excitement".