Investing in Premium Bonds may seem to be a worthwhile move from a risk/reward perspective. After all, there is no chance of losing money due to them being backed by the government. And, with the opportunity to win £1m every month, the returns could be significant.
The reality, though, is that the average returns on Premium Bonds are currently below the level of inflation. As such, Premium Bond holders are receiving a negative return on their investment.
This could mean that other options may be more appealing for investors who are seeking to build a nest egg over the long run. Following value investors such as Warren Buffett, therefore, could increase your chances of retiring early.
Low growth prospects
The annual prize rate of Premium Bonds is essentially the average return that can be expected by bond holders. It currently stands at 1.4%, which is similar to the best rates available on easy-access savings accounts and Cash ISAs.
The annual prize rate moves up and down depending on the level of interest rates. At the present time, for example, low interest rates mean that the annual prize rate is relatively disappointing. Over time, it could rise, but potentially at a slow pace. Interest rates are expected to be only slightly higher in three years’ time than they are today, while Brexit risks may mean that the Bank of England maintains a loose monetary policy over the coming years.
The end result for Premium Bond holders could be that their returns remain below inflation for a sustained period of time. This will reduce their spending power over the long run, and is unlikely to provide a sufficiently large nest egg from which to draw a passive income in retirement.
High growth prospects
This contrasts with the experiences of value investors such as Warren Buffett. The ‘Sage of Omaha’ has become one of the wealthiest people on earth simply through buying stocks while they trade on low valuations.
This strategy may sound too good to be true. After all, it does not require constant activity in terms of buying and selling companies. However, it does require a focus on the quality of a business in terms of its competitive advantage, as well as the discipline needed to wait for the right price to buy.
Then, simply holding a range of such stocks over the long run could realistically produce annual returns that are five times (or more) greater than the current return on Premium Bonds. When compounded, they could build a nest egg from which a passive income can be generated in older age.
Therefore, while Premium Bonds are likely to remain popular, Warren Buffett’s value investing strategy could be a better means of improving your retirement prospects. It’s never been easier to open an online share-dealing account, nor has it ever been cheaper to buy stocks. This could mean that now is the right time to pivot from Premium Bonds to FTSE 350 stocks in order to boost your retirement prospects.
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.