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Forget Premium Bonds: I’d treble my passive income through FTSE 100 dividend shares

The chance of winning £1m attracts a variety of investors to Premium Bonds and with them being backed by the government, there seems to be no downside and only potential upside.

However, the reality is that their annual prize rate of 1.4% is below inflation. It is a similar return to that offered by cash, which suggests that for most people, Premium Bonds could be an inefficient use of capital.

Moreover, with the FTSE 100 offering a dividend yield in excess of 4%, now could be an opportune moment to treble the passive income you receive on Premium Bonds through purchasing a range of large-cap shares.

Income prospects

Although the FTSE 100 may have a yield of over 4%, income-seeking investors can obtain a significantly higher yield than that through buying the highest-yielding stocks in the index. In fact, with the FTSE 100 appearing to trade on a margin of safety due in part to the risks faced by the world economy, a large number of its members have yields that are above that of the index.

As such, it is entirely possible for an investor to build a diverse portfolio of stocks that together have a combined income return in excess of 5%, or even 6%. This could mean that the return on Premium Bonds begins to look relatively unattractive – especially as compounding has an increasingly large impact on the size of an investor’s portfolio over the long run.

Capital growth

As well as a relatively high income return, the FTSE 100 also has proven growth prospects over the long term. In the last decade, for example, it has risen by around 4% per annum despite the world economy facing a period of turmoil over the last few years.

In the coming years, a 4% annualised capital return cannot be guaranteed. Risks such as Brexit and the global trade war may impact negatively on the performance of large-cap stocks, as well as on investor sentiment. But, with the index having delivered strong capital returns over the long run, an investor with a time horizon of a decade or more seems likely to benefit from future bull markets and an increasing portfolio valuation from which to generate a passive income.

Loss of capital

As mentioned, Premium Bonds do not put capital at risk. However, when inflation is factored in, Premium Bonds are currently losing money each year. This situation could remain in place over the medium term, since the annual prize rate is dependent on interest rates. They may remain low due to Brexit fears.

As such, buying a diverse range of FTSE 100 dividend shares could be a worthwhile move at the present time. They have the potential to treble your income when compared to the returns on Premium Bonds, as well as offer capital growth prospects over the long term.

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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.