While the thought of winning £1m on Premium Bonds may be attractive to a wide range of people, the reality is the odds of doing so are very slim. In fact, the average return on Premium Bonds is around 1.4% at present. This means that, for most people, their Premium Bonds are losing money in real terms, since inflation is higher than their return.
By contrast, it’s possible to build a portfolio of FTSE 100 shares that offers an income return which is as much as three times higher than the average return offered by Premium Bonds. Large-cap shares may also deliver capital growth in the long run, which could increase your chances of building a large nest egg so you can retire early.
As mentioned, Premium Bond returns are relatively low for most people. They could remain below inflation over the medium term since the annual prize rate is linked to interest rates. The Bank of England may increase interest rates over the coming years, but it could do so at a modest pace due to the uncertain outlook for the economy. As such, Premium Bond holders may see their returns increase, but it may take time.
Furthermore, interest rate rises are often prompted by a rising inflation rate. This can mean even if a higher interest rate is present in a couple of years’ time, for example, it may still be lower than inflation. As such, Premium Bonds may continue to offer negative real returns, and reduced spending power for their holders.
Although investing in the FTSE 100 carries a risk of capital loss, its risk/reward opportunity appears to be highly favourable in comparison to Premium Bonds. Even if the index doesn’t move higher, an investor could generate a net 5%+ annual return simply from holding a range of dividend stocks in a tax-efficient account such as an ISA.
However, the index could realistically deliver impressive capital returns in the long run. With the FTSE 100 having risen from 1,000 points at inception in 1984 to trade at over 7,000 points today, its track record of growth is encouraging. It shows that while the index may experience periods of disappointment that include bear markets and market corrections, its long-term growth trajectory is generally positive.
Certainly, the potential for a global trade war means there may be a period of volatility ahead. But, for long-term investors who are focused on building a nest egg over a period of many years so they can generate a passive income in retirement, this could certainly present a buying opportunity. As such, FTSE 100 dividend stocks appear to be a better means of achieving the goal of building a nest egg and retiring early, compared to Premium Bonds.
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Peter Stephens has no position in any of the shares 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.