At the start of each month, the prize draw for the Premium Bonds from the NS&I takes place. Prizes range from £25 all the way up to £1m. For many investors, allocating some funds into Premium Bonds is a smart idea. You retain instant access to the funds should you need it, but also have the chance to pick up income on a monthly basis.
Last month, it was announced the amount of prizes being paid out was to be cut from May onward. This meant a reduction in the ‘interest’ rate from 1.4% to 1.3%. We can’t quite term it officially an interest rate because there’s no guarantee of it being paid. However, on average, £10 invested wins you 13/14p worth of prizes over the course of a year.
The 0.1% cut doesn’t sound like a lot, but it’s a reduction nonetheless. That’s why I’m not keeping a large allocation there and continuing to look to stocks for more reliable income.
What income can I pick up from stocks?
Income from Premium Bonds is not certain. While income from a stock also isn’t guaranteed, you can look to invest in firms that have a proven track record of paying out dividends. These dividends are income for an investor. When you compare it as a proportion of the price you paid for the stock, you can find the percentage yield given. From here, you can use it as an unofficial interest rate and compare it to the Premium Bond prize rate.
The current FTSE 100 dividend yield is almost 6%. When you look specifically within the index, you can find a range of options. There are big-cap firms, such as HSBC yielding 8.8%, or long-term investor favourite Lloyds Banking Group yielding 9.8%.
When you compare this to the 1.3% or 1.4% currently on offer from Premium Bonds, it’s easy to see why generating income from stocks is attractive.
How safe is the income from stocks?
A company doesn’t have to pay out a dividend, and during the stock market crash, some firms may cut dividend payments. This is because the firm may be struggling with cash flow issues and needs to cut costs. One easy way to do this is via the dividend. By not paying out income to investors, the firm can focus the funds on ensuring business survival during the Covid-19 pandemic.
We’ve already seen ITV take this step. The firm has cut the dividend as part of a £300m cost-cutting exercise. So income investors who had bought ITV stocks are likely to feel disappointed.
This does mean investors need to be careful about which shares to buy at the moment. However, with the FTSE 100 index as a whole averaging that 6% yield, it’s still significantly higher than the Premium Bond yield. Thus, if I hold all 100 companies within the index, even if 50% of them cut dividends this year, I’m still picking up double the yield than from those bonds.
For me, this highlights the importance of holding stocks for income generation.
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Jonathan Smith owns shares in Lloyds Banking Group. The Motley Fool UK has recommended HSBC Holdings, ITV, and 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.