They are undeniably popular. Their allure comes from a combination of capital security and the chance to win tax-free prizes. Since the global financial crisis really got going last year, security of cash has become an even more important factor when deciding where to keep your money.

But are they worth it? Whilst lots of us own them, many people tell us that they have never won a prize. When compared to the most competitive interest rates available from ordinary savings accounts, the interest rate used to calculate prizes is fairly pitiful. In this article we separate fact from fiction and help you understand whether Premium Bonds are the right home for your cash.

A history lesson

Before we look at the basics, here is a brief history lesson.

Premium Bonds were launched on 1st November 1956 after Harold Macmillan announced them in his April Budget report as a method of reducing inflation and encouraging thrift. £5m worth of Premium Bonds were sold on the first day.

The first prize draw did not take place until June 1957, but by that time over £82m had been invested in Premium Bonds. Over 23,000 prizes were awarded in that first draw and the top prize was £1,000.

After this positive start, the total amount invested in Premium Bonds peaked at around £4bn in the early 1990’s before really taking off in terms of popularity. By 2008, £40bn was held in Premium Bonds.

The basics

A big attraction of Premium Bonds is the relative simplicity of their design. The rules are fairly easy to grasp even if you are usually intimidated by financial products.

Anyone who is 16 years old or over can invest. Under 16’s can also own Premium Bonds if a parent, grandparent or legal guardian buys them on their behalf.

The minimum investment is £100 and the maximum holding per person is £30,000. There is no set investment term and each month your Bonds are entered into the prize draw.

Your money invested in Premium Bonds does not attract interest each month. Instead, you stand the chance of winning a tax-free prize (more on these in a minute).

However, your capital is very secure. Money within Premium Bonds is backed by HM Treasury. This means that there should be no real concerns about default risk or having to resort to the Financial Services Compensation Scheme (FSCS) for compensation.

Meet ERNIE

ERNIE is the Electronic Random Number Indicator Equipment. Since the introduction of Premium Bonds in 1957, ‘he’ has been the one responsible for selecting prize winners. Today, National Savings & Investments is using the fourth generation of ERNIE.

His randomness is ensured by a monthly check by the Government Actuary’s Department (GAD). They then issue a certificate to confirm the randomness of the machine, which is needed before NS&I is able to pay out prizes.

The monthly prize draw includes one £1m jackpot. The other prizes range from £25 to £100,000. For October 2009 the total prize fund was £52.4m and 1,749,056 prizes were distributed in total.

The odds of winning any prize each month (which could be £25 or £1m) have been calculated at 24,000 to 1. In simple terms, this means that for every 24,000 eligible Premium Bonds there is one prize.

This can be compared to the National Lottery, where the odds of winning any prize are in the region of 54 to 1. However, this is a difficult comparison to make because with the National Lottery you lose your ’stake’ each time you enter.

The odds of winning the Premium Bond £1m jackpot each month are in the region of 40,000,000,000 to 1.

Are they worth it?

This is the one million pound question. The prize fund is calculated by reference to a notional interest rate applied to all holdings in Premium Bonds. This interest rate is tax-free and currently stands at 1.5%.

This means that, regardless of your income tax status, if you hold £100 in Premium Bonds you might expect an average annual return of £1.50. If you hold the maximum £30,000 then your average annual return would be £450. Of course many people will receive nothing and some will receive more. It’s a gamble.

Compare this to one of the most competitive instant access savings accounts at the moment; West Bromwich Building Society is offering 2.85% gross with its Branch Easy Access Saver. For a non-taxpayer with £30,000 in savings this means annual interest of £855. Basic rate taxpayers would expect £684 and higher rate taxpayers would receive £513 of net interest.

There are some key differences between Premium Bonds and savings accounts. With the savings account you would know in advance what level of interest you should expect to receive in the year. With Premium Bonds you can have an average prize expectation in a given year. Equally, you might get nothing or you might receive more.

From a capital security perspective, and because the maximum Premium Bonds holding is £30,000, the equivalent amount in savings with a UK financial institution would come under the £50,000 limit of the Financial Services Compensation Scheme (FSCS).

The inflation argument

One argument often made against Premium Bonds is, whilst your capital remains secure and invested for future prize draws, the ‘real’ value of your cash is eroded over time by price inflation. This is because a rate of interest is not physically applied to your cash but future increases to the value of your capital depend entirely on winning prizes.

In the current economic environment, this is less of a concern. The Retail Prices Index (RPI) measure of inflation was -1.4% for the twelve months to September 2009. This means that, even if your Premium Bonds did not win a prize during the past twelve months, the purchasing power of your capital would have improved.

During times of positive price inflation this would not be the case. In fact, it doesn’t get much better if your cash is in a bank or building society account earning interest. Cash is not the place for holding money longer term if you want to maintaining purchasing power and protect it from inflation erosion.

Should you buy them?

Premium Bonds have mass-market appeal. They combine a simple financial product, capital security and the chance to win tax-free cash prizes. In fact, there isn’t a huge amount not to like about them.

They might not be the right home for all of your money, but as a way to take more of an interest in your financial planning and participate in a lottery without losing your stake, they are pretty tough to beat.

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice. You can follow him on Twitter @martinbamford. He used to have some Premium Bonds, never won a penny, got disheartened with the whole thing and sold them.

This ‘rainy day’ money is your financial safety net should you lose your job or have an unexpected bill to pay. It is the cash cushion that keeps you out of debt (and under your roof) when things go wrong financially. It is pretty important to have.

But how do you actually create this magical emergency fund? What are the steps you need to follow to put one in place?

Work out what you need

The first step in building an emergency fund is to work out what you need. Having a specific target to reach makes it easier to get there, plus you will know when you have reached it!

Your monthly household budget is a great starting point for this. Look through the list of everything you spend each month and then draw a red line through the items you could live without. What you are left with is your committed expenditure. In case of a dire financial emergency, this is the stuff you would have to keep paying.

Once you know this figure, you can easily see for how long your existing savings would last if your income stopped tomorrow. Make a note of this. Would it be a day, a week, a month or longer?

Your emergency fund target then becomes a multiple of your committed expenditure, less any existing savings you have earmarked for the purpose of an emergency. There are no hard rules when it comes to what this multiple should be. Whether you pick three months, six months or a completely different figure is up to you. What is important is that you pick a number and work towards it.

Work out where to put it

You will need a good home for your emergency fund, and ‘under the mattress’ probably isn’t the right answer! The most common place for an emergency fund is a savings account with a bank or building society. Assuming your savings with that institution do not exceed the £50,000 limit of the Financial Services Compensation Scheme (FSCS), you can sleep easily at night knowing that your money is completely safe.

The returns you get on the cash in your emergency fund are less important that the financial security of that money and knowing you can get access in the event of a real emergency. Interest rates on savings are really low right now, so shop around to get the best deal you can and keep the interest rate under review.

There are conflicting thoughts on whether or not to opt for a fixed rate savings account for an emergency fund. On the one hand, your money should be readily accessible. On the other, you should not need to access this money unless there was a real financial emergency. Putting the financial barrier of the loss of some interest between you and your emergency fund can make real sense for this reason.

Get building

Once you have your target amount and you have a suitable home for your emergency fund, get building. Unless you have a lot of disposable income to hand it will take time to build your emergency fund from scratch, but the sooner you start the sooner you will reach your goal.

Factor your savings towards an emergency fund each month into your household budget and monitor your progress towards the target amount. Depending on how you prioritise the existence of an emergency fund, you may want to put other financial priorities, such as saving for your retirement, on hold temporarily until your emergency fund is created.

Whatever you do, have a plan and make sure it is documented. Creating an emergency fund (if you do not already have one) should form an integral part of your written Financial Plan and it should be something you review on a regular basis.

Leave it alone!

Once you have built your emergency fund, you need to resist the temptation to dip into it for anything less than a real financial emergency. It helps here to write down the possible reasons for accessing this cash. If your ‘emergency’ doesn’t appear on your list, you cannot touch the money.

The only exception to this ‘leave it alone’ rule is to include your emergency fund in your annual financial review, to make sure it remains at an appropriate level and is earning a competitive rate of interest.

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice.

In short, it was (and still is to some extent) a real mess, and we are all dealing with the consequences.

Economists and historians will tell you that these things come in cycles. When Gordon Brown promised an ‘end to boom and bust’ in his previous role as Chancellor of the Exchequer, you could almost hear the chuckles in the hallways of the London School of Economics.

Yet somehow this time feels a bit different. Whilst nobody can accurately forecast when this recession will come to an end, there are important lessons we can all learn from recent events.

The ‘rules’ of money appear to have changed. In fact, maybe they haven’t changed at all. The following principles could have all applied equally as well before this global financial meltdown. It’s just that following these ‘rules’ in the past would have meant going against the flow.

Here are my six rules for our relationship with our money in the new world of finance.

1 – We cannot rely on property.

In the old world it was so simple. We would put down a minimal deposit, take out a big mortgage and buy a house. Property prices would go up and every couple of years we would take out a slightly bigger mortgage.

How things change.

Falling house prices combined with a particularly brutal credit crunch brought this always unwise financial strategy to a grinding halt. We all feel poorer as a result. The frequent remortgaging before was subsidising our lifestyles. Directly or indirectly, you probably felt wealthier as a result of this money being dragged out of growing property values.

In the new world, we cannot live like this, with that source of cash gone for the foreseeable future. We need to reassess the way we choose to live our financial lives. It is never popular to suggest that people spend less, because spending less often equates to doing less. Yet only buying what you can really afford to buy is one of the most important financial foundations you can create.

2 – Cash is (still) king.

Yes, interest rates are incredibly low at the moment. If you are one of the people who rely on interest from savings to supplement your retirement income, you may be thinking that cash is the last place your money should be.

But cash remains king for several important reasons. It is still the only asset class to offer capital security. Assuming you stick to the limits of the Financial Services Compensation Scheme (FSSC) even a failing bank or building society will not result in the loss of your dosh.

Having a healthy reserve of cash means not having to take on expensive debt in an emergency, assuming said debt is even available when that time comes.

The often quoted concept of building an emergency fund of three to six months typical expenditure is more important today than ever before. Economic recession means uncertainty in the job market which could continue long after world markets start to recover. Having a cash emergency fund is a necessity against this backdrop.

Whilst you might have been able to borrow your way out of financial trouble when an emergency struck, now you would be lucky to find a sympathetic lender. Your cash savings are the only safety net you can rely upon in the future.

3 – It is cool to know about money.

In the old world, financial ignorance as generally acceptable. You could get by comfortably in most cases without much in the way of a financial plan. As long as you continued to earn money and keep up the minimum payments on any debt, the world was your financial oyster.

Today, financial ignorance is about as cool as your drunken uncle dancing at a wedding. To get by these days you need to be money savvy.

The media is lending a helping hand when it comes to meeting this challenge. Thanks to Robert Peston and his colleagues, it’s not considered strange to know the protection limits of the Financial Services Compensation Scheme or to be able to explain the intricate mechanics of quantitative easing.

Taking a healthy interest in this sort of stuff and understanding the bigger economic picture is great, but what really matters is your ability to convert this global overview into meaningful action for your own financial planning.

The press loves to talk about the bigger picture. They regularly throw around figures of billions of pounds and we are supposed to get excited by this. In reality, the billions matter much less to you than the hundreds or thousands which make up your own bank account, mortgage, pension fund or credit card. Practice selfish financial planning, at least until you are fully in control of your own money management, and then you can start looking at the global picture.

4 – Complex financial products suck.

Until the current global financial crisis struck home, it was fine to invest in complex investment schemes promising high returns with limited or no downside potential. In a rising investment market with plenty of cash sloshing around the system these things can work. When the supply of money comes to a sudden stop and the markets begin to crash, the shortcomings of these products is exposed for all to see.

The criminal actions of Bernie Madoff, who ‘made off’ with around $65bn of investor cash, may have been the very worst example of these things going wrong, but many investors have seen promised investment returns fail to materialise.

The simple rule now, as it should always have been, is that if it is too good to be true, it probably is. This includes so-called ’structured products’ which use complex financial instruments to offer capital protection with full exposure to risky investment markets. A guarantee may turn out to be any but a guarantee if one of a handful of factors goes wrong.

This leaves us with a financial world where it makes sense to shun the complex stuff and stick to the basics. There are four main investment asset classes – cash, fixed income securities, equities and property. The rest is all a distraction for 99% of investors. And don’t kid yourself that you somehow fall into that 1% who need to access to the ‘exciting’ alternative investment types.

The overwhelming majority of investors can get by with an appropriate mix of the four main investment asset classes. It is how much of your money you expose to each of them and for how long that counts, and not investing in a Guatemalan hedge-fund offering 28% a year returns with ‘no risk’ to your capital.

5 – We have to take personal responsibility.

The government used to be able to provide for you. You may not have had a particularly good lifestyle in retirement if all you had was the State pension to tide you over, but you could at least retire at age 60 or 65 without the fear of being consigned to abject poverty.

Now, the State cannot provide. An ageing population combined with increased life expectancy and a government in so much debt it makes Argentina in the mid-1990s look wealthy have all put paid to the ability of the State to do much more than keep you from becoming completely destitute when you get older.

We are all going to have to work for much longer if we plan to rely on the State for our retirement income. The State pension age is already scheduled to increase to age 68, for men and women, from 2044, but in practice it could be a later age from an earlier date. The latest thinking is that age 70 will become the minimum retirement age within the next couple of decades. By the time you retire, assuming you are young enough now, it could be even later than that.

What this all means is that taking personal responsibility for retirement planning has become essential. The continued demise of company final salary pension schemes means a combination of personal pensions and non-pension investment assets will be the preferred strategy for anyone planning to avoid a retirement merely surviving rather than thriving.

6 – Substance takes preference over style.

This is where things appear to have shifted quite radically over the past couple of years. If the boom times were about keeping up with the Jones’s, the bust times are about growing your own vegetables, and the waste hierarchy of reduce, reuse and recycle.

A change in attitudes towards consumerism were appearing long before the world plunged into this recession. Any link between personal happiness and buying stuff was weak at best, and it took the removal of easy access to cash to tip an already growing anti-consumerist movement over the edge into mainstream culture.

It is now considered ‘cool’ to make do and mend. Holiday destinations are judged based on their eco-credentials rather than hours of guaranteed sunshine. Demand for allotments has gone through the roof and vegetable seed companies have reported massive sales growth. Charity shops have benefited as our view of the world has been adjusted.

Whilst the great British love affair with shopping may not have been killed off for good, there has been a major attitude shift that could well continue past any economic recovery. People who for so many years were the embodiment of all style, no substance have largely had their day as a new way of living and being takes over.

Martin Bamford is site editor at BrilliantWithMoney and a Chartered Financial Planner with Informed Choice.