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Don’t take 1.15% from Premium Bonds when these 2 income stocks pay over 5%

Photo: Ian Wilson. Cropped & adjusted. Licence: https://creativecommons.org/licenses/by/2.0/

The old ones are the best, at least that’s what Premium Bond holders believe. An incredible 21m people hold onto this relic from the 1950s, vainly hoping that they will be one of two people to hit the £1m jackpot every month.

Broken bond

The odds, I hate to say it, are against you. For each £1 bond you hold, the odds of winning a million are one in 31,653,072,200. Although if you hold £1,000 in bonds, that falls to a more enticing one in 31,653,072.

The odds of winning will be even lower from May, when the average prize rate is cut from today’s feeble 1.25%, to an even floppier 1.15%. Even that is misleadingly high, as returns are skewed towards those few savers who do win a big prize, such as the two £1m jackpots, the three £100,000 payouts, and the six for £60,000. Also, Premium Bonds are the wrong investment for anybody who needs a reliable source of income.

Premium investment

Everybody likes a flutter but I would advise against parking large sums in Premium Bonds. With inflation now at 1.6% and forecast to hit 3.1% this year, the value of your money is being eroded in real terms. If your luck is out it will erode at an even faster rate.

So why put up with a potential 1.15% a year when plenty of top blue-chip stocks pay more than 5% a year, with the opportunity for capital growth on top? I am thinking of stocks like British Gas owner Centrica (LSE: CNA), which currently offers a dividend yield of 5.13%. The gas and electricity supplier has more than 14m customers, and although competition in the market is tightening it remains the big beast.

Life’s a gas

Centrica has had several tough years, with threats of a price freeze, mild winters hitting demand, and falling energy prices reducing margins. However, the last 12 months have been far better, with the share price up 24% in that time.

That dividend isn’t guaranteed, it is covered just 1.4 times by profits, but with Centrica’s earnings per share (EPS) forecast to grow 3% this year and 9% in 2018, it should generate enough cash to keep the payouts flowing, especially with a major cost-savings plan to come.

Drugs do work

Pharmaceutical giant GlaxoSmithKline (LSE: GSK) is another income machine, currently yielding 5.03%, more than four times the Premium Bond average prize rate, again, with capital growth on top. Over the last 12 months, the share is up almost 18%, a big win for investors.

The dividend is covered 1.3 times, relatively thin for Glaxo, but EPS forecasts are healthy at 9% for this year and 3% for 2018, so it should remain secure. Last week we saw the company hit its full-year earnings target while warning that growth could be hurt by looming generic competition to its Advair respiratory drug, slashing US sales by as much as 45% to £1bn.

Glaxo also reported that new product sales more than doubled to £4.5bn, representing 24% of drugs, which should help offset Advair losses. Centrica and Glaxo are both premium investments. In contrast to Premium Bonds, the odds of a payout are firmly in your favour. All will have prizes.

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Harvey Jones has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended Centrica. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.