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Investing in Premium Bonds for your children? That could be a huge mistake

Investing money for your children while they are still young is a smart financial move as it can set them up for life. Over time, even a small amount of money put away can grow into a substantial sum.

That said, if you want to give your children a financial advantage in life, it’s crucial to invest in the right assets. You need assets that will grow at a rate above inflation and enable you to compound your returns over time, as this is the key to building wealth. With that in mind, here’s a look at why NS&I Premium Bonds aren’t a great investment for children.

Low growth 

The main problem with Premium Bonds, from a wealth-building point of view, is that they pay no regular income. While they advertise an interest rate of 1.4%, this is only paid out in prizes and the odds of winning a prize (24,500 to one for each £1 bond) are quite unattractive. This lack of regular income means that, as a long-term compounder, Premium Bonds are highly ineffective.

Even if you did manage to pick up a return of 1.4% per year on average through Premium Bonds, the original investment wouldn’t grow much over time. For example, if you invested £2,000 in Premium Bonds for a child when they were born and you let this money grow until their 21st birthday, it would only be worth around £2,678 in the end, according to my calculations. By their 30th birthday, it would be worth just over £3,000. When you factor in inflation, the money would most likely be worth less, in real terms, than it is worth today.

Given this lack of inflation protection, Premium Bonds probably aren’t the best asset to go for if you’re saving for your children.

Life-changing wealth

If you’re looking to set your children up financially, an investment in stocks, within a Junior ISA (where all gains are tax-free) is a much better idea, in my view. Over the long run, stocks tend to generate returns of around 6%-10% per year on average (well above inflation), meaning they’re a very effective way of building wealth. Over time, stocks can turn a little bit of money into quite a significant sum.

For example, let’s say you invested £2,000 in a diversified portfolio of stocks for a child when they were born and you let this money grow until their 21st birthday. Assuming a return of 8% per year on average, this money would be worth just over £10,000 by their 21st birthday, which is a fair amount of money. And if you left it until their 30th birthday, it would grow to over £20,000! That’s the power of the stock market for you – over time, the results can be very impressive.

In summary, if you’re looking to invest for your children, I say ditch the Premium Bonds and invest in stocks instead. Your children will thank you for it down the line.

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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.