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Forget NS&I Premium Bonds. I’d buy UK dividend shares for a passive income

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NS&I Premium Bonds are one of the safest investments around. NS&I is backed by the UK government, which means it’s highly unlikely investors will lose any money they put towards these assets. Unfortunately, they do not match UK dividend shares when it comes to passive income potential. 

NS&I Premium Bonds: Drawbacks 

Just because the government backs Premium Bonds, it doesn’t mean they are good investments.

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Indeed, after the recent round of prize pool cuts, Premium Bonds now offer terrible return rates.

What’s more, these investments do not produce a guaranteed rate of return. Owners are entered into a monthly prize draw, and while you can win a significant amount with these draws, nothing is guaranteed. 

As such, if you are looking to generate a passive income stream, I highly recommend avoiding NS&I Premium Bonds. I would buy UK dividend shares for a passive income instead. 

UK dividend shares

From December onwards, the prize draw interest rate for Premium Bonds will fall to just 1%. In comparison, the FTSE 100 currently supports a dividend yield of around 4%. 

Immediately, this suggests that UK dividend shares are a better instrument to produce a passive income than government-backed bonds. 

Some investors and savers might be wary of investing in stocks because of the additional volatility.

While it is right that stocks can be volatile, over the long term, investors tend to see extremely positive returns. For example, over the past few decades, a diversified basket of blue-chip dividend stocks would have produced an average annual total return of around 8%. 

Passive income stream

In my opinion, this is best way to build a passive income stream with UK dividend shares. A selection of high-quality blue-chip stocks such as Unilever and GlaxoSmithKline could provide the perfect blend of income and capital growth over the long term. It should also minimise the risk of investors seeing a considerable loss in their portfolios. 

Another approach could be to buy a low-cost index tracker fund. These simple funds by the whole index of stocks, allowing investors to profit from the average dividend without having to worry about selecting individual securities. This could be a great place to start for investors who are not too sure about the market and want to minimise their risk while maximising profits.

Combining NS&I Premium Bonds and UK dividend shares, maybe the best approach for investors who want to generate a passive income with reduced risk.

For example, a 50/50 portfolio of Premium Bonds and blue-chip stocks yielding 4%, could produce an income return of around 3% every year. That’s excluding capital growth. This offers investors the best of both worlds, capital protection with bonds and additional growth and income with equities.

That’s why I would buy UK dividend shares for a passive income over Premium Bonds. 

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Rupert Hargreaves owns shares in Unilever. The Motley Fool UK has recommended GlaxoSmithKline 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.

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