Premium Bonds have been a popular means for people of all ages to save for the future. They are backed by the government, so the risk of losing money is exceptionally low. And in the past, they have provided a generous return for many winning bondholders, which has often been ahead of inflation.
Today though, Premium Bonds appear to lack appeal. Their average return stands at around 1.4%, and could remain at a low level due to the future prospects for interest rates.
Therefore, opening a Stocks and Shares ISA and buying shares could be a better idea for investors who have a long-term horizon and who are seeking to make a million.
Premium Bond woes
Since the average returns on Premium Bonds are linked to interest rates, their outlook appears to be rather disappointing. Due in part to inflation being expected to remain at 2% or less over the next year, the Bank of England is forecast to retain a dovish stance on monetary policy. This could mean that the average return on Premium Bonds remains at less than inflation. That means they could offer negative real returns over the medium term.
The impact of negative real-terms returns on your spending power can be very disappointing. Over time, your capital will be able to buy fewer goods and services than today, which can make you feel poorer, despite working hard to save money on a regular basis.
Stocks and Shares ISA
The low returns available on Premium Bonds contrast with the high returns that may be on offer from Stocks and Shares ISAs. Investing in the stock market through the tax-efficient product can lead to impressive returns in the long run. For example, the FTSE 100 could generate a high-single-digit annualised return over the long run that easily outperforms the average returns on Premium Bonds.
Since no tax is charged on investments held within a Stocks and Shares ISA, the net return will be the same as the gross return for many investors. Certainly, there is much greater risk in investing in the stock market than Premium Bonds. But by diversifying across a range of companies, it may be possible to reduce your risk of capital loss. Moreover, in the long run, the FTSE 100 and other indexes are likely to produce recoveries from their downturns.
While having some of your capital in Premium Bonds may be a worthwhile move, since it could provide a higher return than cash, investing through a Stocks and Shares ISA may be a better idea. It could produce higher returns that beat inflation over the long run. This may lead to an increase in your spending power that improves your chances of making a million in the coming years.
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Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2019