Making a million from Premium Bonds is an exciting, but unrealistic, prospect for the vast majority of people. In fact, with interest rates being low at the present time, the prize rate for Premium Bonds is currently 1.4%. As such, the average return for most people who buy Premium Bonds is a similar level to the current rate of inflation.
Therefore, the FTSE 100 could be a better place to invest if you have £20k, or any other amount, currently available and are seeking to turn it into a million. It offers higher return potential – especially at the present time after its volatile start to 2020. And, while it comes with higher risks than Premium Bonds, they can be reduced through diversification and focusing your capital on higher-quality businesses.
While Premium Bonds may struggle to deliver a positive after-inflation annual return, the FTSE 100 has a strong track record of doing so. In fact, it has produced a total annual return of around 9% since its inception 36 years ago.
Assuming a similar rate of growth in future could mean that an initial investment of £20k becomes £1m after around 46 years. While this may not sound especially impressive, since many people may not have a 46-year time horizon, it highlights the return potential of the FTSE 100 compared to Premium Bonds. In fact, the same £20k invested in Premium Bonds at its current annual prize rate of 1.4% would be worth just £38k by the end of the same time period.
Clearly, the FTSE 100 is a far riskier investment prospect than Premium Bonds. While the latter is backed by the government, the former is subject to wild swings in value which can lead to significant paper losses for investors.
Those risks, however, can be reduced through buying high-quality businesses while they trade on low valuations. For example, companies that have solid balance sheets and strong cash flow may offer more robust earnings outlooks, while undervalued shares could offer more attractive risk/reward ratios that limit your potential losses.
In addition, diversifying across a wide range of shares helps to limit the impact on your portfolio of losses for a small number of holdings. With it being cheaper than ever to buy shares through tax-efficient accounts, such as a Stocks and Shares ISA, diversifying your portfolio has become more cost-effective than ever.
Making a million
While investing £20k in the FTSE 100 is likely to take a long time to generate a seven-figure portfolio, the chances of it taking place appear to be much higher than an investment in Premium Bonds. As such, while the index currently appears to offer good value for money, now could be a good time to start building your diverse portfolio of shares that offer a potent mix of income and growth potential.
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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.