October’s £1m Premium Bond winners have been announced. If you are one of them, then congratulations to you. However, the odds of a bond winning anything are 24,500 to 1, and winners should expect £25, not £1m, in the monthly draw. So, let’s not let the headlines distract us: the vast majority of bondholders are still waiting for a windfall.
With that in mind, it’s worth asking what a Premium Bond buyer can expect from their investment. Once we know that we can take a look and see if there are other investments that could build more wealth.
Premium Bond investing
Let’s explore what will happen with a £100 monthly investment in Premium Bonds (which cost £1 each) over 25 years. With no prizes, £30,000 would be saved over a quarter of a decade. But, we should consider the possibility of winning something.
Prize draw details are available on the issuer’s (National Savings and Investments) website. I used the probabilities of winning various prizes to work out how much wealth investing £100 each month for 25 years in Premium Bonds might generate. On average the wealth level was £36,040. Premium Bond investors can expect to end up with £40,950 or less 99% of the time.
Crunching the numbers reveals that 99% of the time, investors can expect a 2.4% annual return or worse on their Premium Bond investment, as described. There are investment options out there that can yield more than this. Before we get to them though it’s worth pointing out a few selling points of Premium Bond investing. The UK Treasury backs any savings and prize money, so an investor will never get back less than they put in. Additionally, Premium Bond prizes are entirely tax-free.
Stock market investing
Investing in the stock market has historically delivered better returns compared with investing in Premium Bonds. The FTSE 100 has delivered an average total return (including dividend reinvestment) of about 6.4% over the last 25 years. Investing £100 per month in a low-cost FTSE 100 index tracker could grow to £72,160 over 25 years.
Picking the right individual stocks to invest in could make an investor even richer. For example, Unilever, Diageo, and Reckitt Benckiser shareholders have enjoyed average returns of around 12.2%, 11.4%, and 10.1% over the last 10 years. And those are relatively safe, dividend-paying stocks. There are other – albeit riskier – growth stocks that could return even more.
Playing it safe
Stock market investing can be done on a tax-free basis, just like Premium Bond investing, inside a Stocks and Shares ISA. Investing in the stock market can, unlike Premium Bonds, return less than was put in. The best defence against this is to maintain a diverse portfolio. This can be done by investing in a fund that tracks an index or investing in multiple stocks. Being able to stick with a stock market investment for years – to allow market crashes time to correct themselves – is also advisable.
I am not going to tell anyone to stop investing in Premium Bonds. However, as long as an investor knows and understands the risks, and invests sensibly, they are more likely to build greater wealth by investing in the stock market.
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James J. McCombie owns shares of Diageo and Unilever. The Motley Fool UK has recommended Diageo and Unilever. 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.