If you are thinking about giving the gift of Premium Bonds for Christmas, I think you should pay close attention to what you are really buying.
The primary attraction of Premium Bonds is that they are backed by the Treasury, making them one of the safest assets you can buy. However, over the past 10 years, Premium Bond returns have plummeted.
These assets do not offer an interest rate. Instead, Premium Bond owners are entered into a monthly prize draw with the opportunity to win between £25 and £1m.
The thing is, the chances of winning anything are just one in 24,500 for each draw. What’s more, the annual prize fund interest rate is only 1.4%. And Cash ISAs aren’t any better either. By comparison, the best flexible Cash ISA interest rate on the market today is 1.36%.
To put it another way, Premium Bonds don’t offer a regular income and don’t protect your savings from the scourge of inflation.
And with this being the case, I think it would be best to avoid them altogether and invest in the stock market instead.
Stocks vs. bonds
Premium Bonds are a long-term investment, and the same is true of stocks and shares. The primary difference is that over the past 10 years, the average annual prize fund rate for Premium Bonds has slumped to that below-inflation level, but the FTSE 250 has produced an average annual return of more than 11%.
The impact this additional 9.6% per annum return can have on your money over the long term cannot be understated.
A sum of £1,000 invested at an average annual rate of return of 1.4%, would grow to be worth £1,150 in a decade (that’s assuming the Premium Bond paid out every year). The same £1,000 invested at 11% would grow to be worth £2,989 after 10 years.
Looking at these figures, if you want to build a million-pound savings pot, then the best strategy to use is to invest your money in the FTSE 250.
Investing in the market
According to my calculations, to make a million this way, you would need to invest a lump sum of £20,000 for 36 years assuming an average annual rate of return of 11%.
If you don’t have £20,000, small monthly investments will achieve the same aim according to my figures. I estimate that it would take 42 years of saving £100 a month to build a million-pound savings pot, assuming an average interest rate of 11% per annum.
The bigger the monthly contribution, the easier it becomes to hit this target. £250 a month is, according to my figures, enough to build a £1m pot within 34 years, assuming an average interest rate of 11%. And £400 a month would get you there in 29 years.
The bottom line
So, that’s why I would ignore Premium Bonds altogether and invest my money in the stock market instead.
The market offers much better returns over the long term as well as a regular income stream from dividends. By comparison, Premium Bonds do not provide a guaranteed return, and due to the impact of inflation, it is likely that the money invested will lose purchasing power over the long term.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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