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Forget Premium Bonds. I’m aiming for returns of 7-10% per year here

In the current low interest rate environment, in which many savings accounts are paying less than 1%, everyone is looking for ways to boost their savings. NS&I Premium Bonds are one savings product that many people are turning to. Currently, these offer an annual prize fund interest rate of 1.4%, and all prizes are tax-free.

Personally, I see very little appeal in Premium Bonds. Here, I’ll explain why I’d give them a miss, and look at where I’d park my long-term savings instead.

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Premium Bonds: not worth it

From a wealth-building perspective, Premium Bonds have several major flaws, in my view. For starters, they pay no regular income. This means they’re not really suitable for anyone who is (a) looking for a regular return on their savings (i.e. retirees), or (b) looking to take advantage of the power of compounding (earning interest on interest).

Secondly, the odds of winning big cash prizes are poor. Overall, the odds of winning a cash prize for each £1 bond number are 24,500 to one. Meanwhile, the odds of winning the jackpot are around 41bn to one. These odds are summed up well by the Money Advice Service: “Your chances of winning the top prize are very slim – most people will win smaller prizes or nothing at all.”

Finally, even if you do average a return of 1.4% from Premium Bonds, that’s still a very poor return. That kind of return isn’t going to protect you from inflation. Ultimately, if you’re earning 1.4% on your money over the long run, you’re going to be going backwards financially.

So, all in all, I see Premium Bonds as a lousy investment.

Returns of 7-10% per year

If you’re investing for the long term, I say forget about Premium Bonds, or any other cash-based savings products, and invest in the stock market instead. This is where I invest the bulk of my own long-term savings.

Yes, stocks can be volatile in the short term. Earlier in the year, we saw just how volatile stocks can be when markets crashed due to Covid-19. However, in the long run, stocks tend to produce much higher returns than cash savings products, such as Premium Bonds.

Indeed, over the long run, stocks tend to produce returns of around 7-10% per year. For example, the S&P 500 index, which is the most followed stock market index in the world, has returned about 10% per year, on average, since its inception in 1926. Earning that kind of return on your money can make a big difference to your wealth over time.

It’s even possible to do better than this if you pick the right investments. For example, the very popular Fundsmith Equity fund, which I’ve invested in, has returned nearly 20% per year over the last five years. 

Of course, the stock market isn’t suitable for all investors. Stocks are a higher risk investment as your capital is at risk. However, if your goal is to build wealth over the long term, as mine is, stocks are a bit of a no brainer, in my opinion.

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Views expressed 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.