It’s been nearly 65 years since the government-backed savings provider NS&I launched Premium Bonds to try and get people across the UK saving. And since the launch, the products have become exceptionally popular with estimates suggesting nearly 1 in 3 people in Britain hold Premium Bonds.
However, while the Treasury-backed bonds are virtually risk-free, they don’t offer a regular interest payout. Instead, every month, savers are given a chance to win tax-free prizes ranging from £25 to £1m. As the minimum initial investment for Premium Bonds was cut from £100 to £25 at the beginning of this year, savers could see a quick return on their money. But the reality is the odds of winning a prize are currently 24,500 to one.
The closest thing they have to an interest rate is what NS&I calls the annual prize rate, which is currently 1.4%. In theory, this is how much interest every saver will receive on average over the long term. But in practice, the amount actually received will vary greatly and there’s a good chance you’ll never actually win anything from the prize pot.
With this being the case, I’m not a massive fan of Premium Bonds. Indeed, I can think of at least one unrestricted savings account on the market today that offers a higher interest rate with interest paid monthly. I would rather put my money here than take the chances of winning a prize with NS&I.
And if you want to get rich, I recommend investing your money rather than taking your chances here.
A better return
The most common reason why people choose Premium Bonds over other assets, despite their low return, is the fact the Treasury guarantees them. This is a solid argument, but the data also shows that over the long term, the chances of you suffering a total loss from a diversified portfolio of equities is almost non-existent.
Buying an index tracker fund that tracks a global index such as the FTSE 100, would not only give you a higher level of regular income, but it would also provide capital growth. At the time of writing, the FTSE 100 supports an average dividend yield of around 4.5%, more than twice the targeted prize fund return offered by Premium Bonds.
If you’re not comfortable with the volatility that comes with equity investing, bond funds could also be a good alternative. You can achieve a yield of 2-5% from bond funds, according to my research, which is once again significantly higher than the rate of return offered by Premium Bonds.
The benefits of compounding
The impact just a few extra percentage points of return will have on your wealth over the long term cannot be understated. Even if you do win a prize equivalent to the annual prize rate, an investment of £1,000 will grow to be worth £1,149 over a decade. By comparison, the same £1,000 investment in an equity or bond fund that yields an annual return of 5% per annum will grow to be worth £1,629 in the space of 10 years.
I think these numbers illustrate the point clearly. If you want to build wealth over the long term, the best option is to avoid low-yielding Premium Bonds.
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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.