The Motley Fool

Forget 1.4% from Premium Bonds: I’d pick up 25% risk-free from a Lifetime ISA

Even though Premium Bonds offer the chance for you to win £1m, the reality is that the average return is 1.4%. That’s the Annual Prize Rate that rises and falls depending on interest rates.

Looking ahead, a lack of interest rate rises may mean that Premium Bonds continue to offer disappointing returns over the medium term.

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By contrast, investing in the stock market through a Lifetime ISA could offer a 25% risk-free return, as well as scope to generate additional returns from future rises in the FTSE 100 and FTSE 250.

25% risk-free returns

Lifetime ISAs offer a government bonus of 25% on all contributions made to the product within a tax year. Since the annual amount you can invest is £4,000, this can amount to a £1,000 government bonus per year.

The government bonus is payable to anyone who has a Lifetime ISA and is aged between 18 and 50, at which point no further contributions can be made to the product.

While there is a penalty for withdrawing money from a Lifetime ISA when you are aged under 60 or when it is not used to purchase your first home, leaving your contributions in the product over the long run means you are guaranteed to earn 25% on your capital without taking any further action.

As such, before even considering where to invest your hard-earned cash, a Lifetime ISA provides an instant boost to your long-term financial prospects.

Premium Bonds

This is in contrast to the returns which are available on Premium Bonds. While the Annual Prize Rate could increase over the coming years, the reality is that interest rate rises are likely to be relatively slow.

For example, interest rates are forecast to be little more than 1% in three years’ time. As such, it may take a number of years for them to return to ‘normal’ levels of 4%-5%. So Premium Bonds could realistically underperform inflation for some time, which means that the spending power of amounts invested in them is set to decline.

Stock market investing

As well as the 25% return available from a Lifetime ISA’s government bonus, investing in the FTSE 100 and FTSE 250 could deliver additional returns over the long run. Both indices have strong track records of high total returns. When the impact of compounding is factored in, they may provide a significantly more appealing retirement nest egg when compared to capital that has been invested in Premium Bonds.

While investing in shares carries greater risk than buying Premium Bonds, history shows that stock markets have always recovered from their downturns. As such, buying a range of shares could reduce their overall risk and enable you to improve your long-term financial prospects. Alongside a 25% risk-free return, this could increase the appeal of a Lifetime ISA when compared to Premium Bonds.

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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.