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Forget the February Premium Bond draw! I’d generate regular income this way

At the start of each month, the Premium Bond draw from National Savings and Investments (NS&I) generates a lot of interest. After all, here in the UK, it’s estimated that 22 million of us (myself included) own some Premium Bonds.

This has been touted as a ‘free lottery’ in the sense that your bond is backed by the Government, so the risk of you not getting back your initial investment is extremely low. While it doesn’t pay interest like a normal bond coupon, you get entered into a prize draw each month to win prizes ranging from £25 to £1m. Over a period of time, most Premium Bond holders hope to win some form of prize.

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But if you’re wanting to generate regular income from your investments, are Premium Bonds really better than buying a dividend-paying stock?

A numbers game

As with most things finance-related, it’s easier to make money when you already have money. This seems like a sweeping generalisation, but there are plenty of examples that prove this. At a basic level, if you bought £1,000 worth of a stock and it rallied 10%, you would make £100. If you invested £100,000, you would make £10,000. 

This principle holds true in a different sense when looking for income either via a dividend-paying stock or via Premium Bonds. With the latter, the more you ‘invest’, the more likely you are to win cash prizes (just think of it as buying more lottery tickets for the same draw). Premium Bonds have an average return of about 1.25%, So if we’re comparing £1,000 of a dividend-paying stock to £10,000 of premium bonds, I would opt for the bonds, purely from a numbers point of view.

But if we were comparing the same notional amount of investment in both a dividend-paying stock and the bonds, I would opt for the stock. Why? Simply because, despite that average return figure, there’s no guarantee of me winning anything from the Premium Bond draw, whereas if a firm states it’s paying a dividend, I know exactly how much I will get paid.

Certain versus uncertain income

The key part in all of this is ‘regular income’ that I mentioned in the title. For example, you can go to the HSBC investor website and see all the historical dividends over the years that the company has paid. It varies slightly year-on-year, but these dividends are pair regularly. The current dividend yield stands at 5.35%. So would you rather have this 5.35% (with limited volatility) or have a possible 0% on the bonds but have the potential upside (a one-in-34bn chance that you could win £1m)?

I’d choose HSBC, but it’s not the only one I’d go for as there are many reliable, dividend-paying stocks on the FTSE 100.

Ultimately, whether to buy stocks or Premium Bonds is a call each investor makes for his or herself, but don’t feel like it has to be a choice of one or the other. Diversification in investments is very important. That is why I hold both dividend-paying stocks and some Premium Bonds. It enables me to spread my risk over different asset classes and means I have regular income from dividends, but also a potential huge upside from a prize draw win. The biggest chunk of my investment cash still goes into shares though!

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Jonathan Smith does not own shares in HSBC. The Motley Fool UK has recommended HSBC Holdings. 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.