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Forget the May Premium Bond draw! I’d invest £1,000 into income-paying stocks instead

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Every month, the Premium Bond draw from the NS&I happens. The aim for anyone who has bought bonds is to win some form of payout. This could be £25, or potentially £1m. It could also be zero.

Despite the unpredictability of the Premium Bond draw each month, millions of us here in the UK own these bonds. But as investors, unpredictability is something we want to minimise as much as possible. When it comes to our hard-earned money, if we want the chance to make income from it, the Premium Bond draw isn’t the best way in my opinion. I’d much rather looks to income-paying stocks instead.

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How do I get income from stocks?

If you invest £1,000 into a stock, there are two elements of the investment. Firstly, the potential gain/loss from the share price. This fluctuates on a daily basis. Secondly, the income received from dividends being paid. Dividends do fluctuate, but only on a six-month or annual basis. Dividends also don’t go negative, so there is no risk of loss from this. You’ll only ever be paid zero or above, as income.

Some firms don’t pay dividends, which means your only potential gain comes from the share price movements. 

Premium Bond income vs stocks

We can actually run the maths fairly accurately on this one. The average interest rate for premium bonds is 1.4%. So the £1,000 generates £14 a year. The FTSE 100 average dividend yield is 4.5%. This means you earn an extra £31 per £1,000 investment from income-paying stocks.

There’s a second powerful reason why I prefer stocks over Premium Bonds. The above interest rate quoted for the bonds is the average. Some bond-holders will get more, many will get much less. In reality, an average isn’t the best way of measuring income. As an investor, you want a definite figure. Unfortunately, premium bonds can’t offer you this. You may earn £0 from your £1,000 investment from bonds, it all depends on luck.

Now, if I invest in a stock, which announces an equivalent of a 5% dividend yield payout, I know I’ll receive it. This gives me certainty around the amount of income I’ll be receiving. 

Dividend-paying stocks I like

At the moment, you do need to pick your stocks wisely, as some FTSE 100 companies has cut dividends for this year due to the Covid-19 pandemic. There are still some good buys out there that pay income. I recently wrote about some here.

In short, both Legal & General and St. James’s Place are committed to paying out some form of dividend to investors this year. Both firms also have a dividend yield around (if not higher than) the FTSE 100 average yield. Given that the firms operate in financial services, the hit to future profitability shouldn’t be as hard as sectors such as retail and travel.

Overall, when weighing up investing in Premium Bonds or income stocks, remember that income on bonds isn’t guaranteed. Sure, you do have the upside to make a million, but look at the odds of that happening. I’ll let you do the maths.

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Jonathan Smith and The Motley Fool UK have 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.

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