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Why I’d ditch Premium Bonds and follow these 3 steps to get rich and retire early

While buying Premium Bonds has been a popular risk-free means of saving for many years, the returns offered are relatively unappealing.

With an annual prize rate of 1.4%, the long-term returns are little different than the best Cash ISAs. Crucially, their returns are below inflation, which means for the vast majority of people, the value of their Premium Bonds will be falling each year in real terms.

As such, there may be better ways to improve your financial position and even retire early. Here are three steps that could help to increase your chances of doing so.

Invest in mid-cap shares

While the FTSE 100 may be the best-known index in the UK, over the last couple of decades it has failed to deliver impressive returns. In fact, after reaching almost 7,000 points in 1999, it currently trades at less than 5% above that level.

By contrast, the FTSE 250 has recorded annualised total returns in excess of 9% over the same time period. That’s well ahead of the FTSE 100’s gains, and is also significantly higher than the return offered by Premium Bonds.

Although there’s a risk of capital loss from investing in shares, while Premium Bonds are risk-free, for long-term investors their risk/reward ratio could be much more appealing.

Reinvest dividends

Although it’s tempting to spend the dividends received on shares, doing so will reduce the total returns generated in the long run. The impact of compounding will be reduced, with a surprisingly large proportion of total returns over the long run derived from the reinvestment of dividends.

As such, it may be a good idea to use the automatic dividend reinvestment feature that’s offered by many online sharedealing providers. Doing so could make a significant difference to your chances of retiring early – especially since the FTSE 250 has a yield of around 3% at the present time.

Diversify to reduce risk

With the stock market likely to experience a number of bear markets and recessions during an investor’s lifetime, reducing risk where possible can be a shrewd move. Doing so may help to smooth out returns, and also produce a more robust return in the long run.

While it’s not possible to reduce market risk when investing in shares, company-specific risk can be neutralised through diversification. With a variety of companies operating in different industries and geographies listed in the FTSE 250, it’s possible for an investor to build a diverse portfolio relatively easily.

Although diversification may not seem to be the most important consideration for an investor who is seeking to retire early, doing so can lead to improved long-term performance and a higher chance of being financially free in older age. While shares will still be riskier than Premium Bonds, their return potential may make them more appealing over the long run.

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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.