The Motley Fool

Warning! Premium Bonds could be the worst way to get rich and retire early

While Premium Bonds have been a popular investment option for many over the years, in reality they offer a relatively poor rate of return. In fact, the annual prize rate is just 1.4%, comparable to those rates currently available on a Cash ISA or bog-standard savings account.

Although the prize rate could increase in future if interest rates move higher, this is likely to be prompted by a rising inflation rate. That, in turn, leads to a loss of spending power for Premium Bond holders.

As such, with the FTSE 100 and FTSE 250 offering a wide range of growth opportunities at present, buying a diverse range of stocks could be a better means of getting rich and retiring early.

Low returns

While some Premium Bond holders will win life-changing sums, the reality is that, on average, returns available amount to that meagre 1.4% per year. Even over a longer period, such as 30 years, this would turn a £1,000 investment into just £1,517.

When inflation is factored in, this is likely to mean the value of Premium Bonds falls further in terms of their spending power. As a result, bond holders may be getting poorer in real terms because they’re holding an asset with such a low average return.

Interest rate rises

Of course, the returns available on Premium Bonds are likely to rise over the coming years. The annual prize rate changes depending on interest rates, which are forecast to increase in the long run towards historically ‘normal’ levels.

That process, though, is likely to be slow. The Bank of England is unlikely to risk jeopardising the UK’s economic growth rate at a time of political and economic change. And, with interest rates often prompted by inflation, it may take a higher rate than at present to force an interest rate rise. In that scenario, the loss of spending power from holding Premium Bonds could be even greater than it is at present.

Growth opportunity

With a number of FTSE 350 stocks currently appearing to offer good value for money, there are a variety of opportunities to generate higher returns than Premium Bonds. Over the long run, FTSE 100 and FTSE 250 stocks have historically produced annualised total returns in the high-single digits.

Assuming this is the continuing case, an 8% annual return over a 30-year time period could turn a £1,000 investment into over £10,000. This would be over six times the expected future value of a £1,000 investment in Premium Bonds.

As such, for investors who are seeking to get rich and retire early, the stock market could offer a more favourable opportunity. While there’s a risk of capital loss, through diversifying and adopting a long-term timeframe, it may be possible to enjoy greater financial freedom in older age.

Your 10 Step Guide To Making A Million In The Stock Market

A world-famous investor once said “Be greedy when others are fearful”. Here at The Motley Fool, we firmly believe that taking a different investing approach could also lead to significant potential gains for you. Get on the inside track today by reading our “10 Step Guide To Making A Million In The Market.” Click here to download for your FREE copy now.

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.