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The Premium Bond interest rate is to be cut. Here’s what I’d do now

Yesterday, NS&I announced that the ‘annual prize fund interest rate’ on its popular savings product, Premium Bonds, is set to be cut from 1.4% to 1.3%. The odds of winning a prize per £1 bond are also set to change from 24,500 to one to 26,000 to one. These changes will kick in at the start of May.

This is disappointing news for Premium Bonds savers. The annual prize fund interest rate was already quite low relative to inflation and it’s set to be reduced further. So what’s the best move for savers and investors now?

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Can you do better?

Personally, I think this reduction in the interest rate could be a good excuse to ditch Premium Bonds for a better alternative, as I see them as a rather poor way of saving for the future.

The thing I don’t like about Premium Bonds is that they pay no regular income. Yes, they offer savers the chance to win large cash prizes, however, the odds of winning a prize are not great and are set to get worse. This means if you have an unlucky streak, your overall returns could be very disappointing. 

In addition, the overall annual prize fund interest rate is less than inflation. This means that, unless you win a major prize, you’re basically going to get poorer in real spending terms, over time.

All things considered, I think there are much better options for saving and investing in the UK. But what are some alternatives?

Short-term savings

If your savings goals are short-term in nature, it’s worth checking out the top savings account interest rates on offer at the moment. Right now, there are some reasonable interest rates around (2%+) from the likes of Coventry Bank and Virgin Money, although these tend to have restrictions on how much you can deposit per month. You’re not going to get rich with these kinds of accounts, but they could help you get a little more out of your money.

Long-term savings

If your savings goals are more long-term focused, I’d consider an investment in the stock market. While stocks are quite volatile in the short term, over the long run they tend to produce much higher returns from cash savings products.

For example, since its inception in 1984, the FTSE 100 index – the stock market index made up of the largest 100 companies listed on the London Stock Exchange – has generated annualised returns of around 9% per year. Meanwhile, the main stock market index in the US, the S&P 500, has delivered returns of about 10% per year since 1926. These returns are far superior to those from cash savings over the long term.

I’ll also point out that there are many well-known UK income stocks that offer fantastic dividend yields right now. For instance, Royal Dutch Shell shares currently offer a yield of around 7.5%. Similarly, Lloyds Bank and Legal & General shares offer yields of around 6.2% and 5.9% respectively.

Picking up that kind of yield and reinvesting it to compound your money (earning a return on your past returns) could make a big difference to your wealth over time.

Of course, it’s important to understand the risks of investing in the stock market. You may not get back what you invested. However, history suggests if you invest with a long-term view, you’re likely to be rewarded.

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Edward Sheldon owns shares in Royal Dutch Shell, Lloyds Banking Group and Legal & General Group. The Motley Fool UK has recommended Lloyds Banking Group. 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.