The October Premium Bond draw has just happened, with millions of investors hoping to win big. For decades, it has been a popular investment for many people. The risk of losing money is virtually zero as the bonds are backed indirectly by the government. But even though you could potentially win a million as the top prize, the average income actually equates to just 1.4% per annum. This is still considerably better than the interest you would get holding the money in cash, but is it really the best way to make a healthy return?
Potential versus guarantee
The monthly Premium Bond draw gets a lot of attention, of course, because of the potential winnings. But therein lies the main issue with Premium Bonds. No income on a monthly or annual basis is guaranteed. You could win £0, in which case the investment hasn’t been worth it for that month… or the next one.
On the other hand, investing in a FTSE 100 stock that pays a dividend can give you income that’s more certain. If the company has committed to paying out the dividend, then it’ll be paid. For me, this process is a lot more secure than Premium Bonds. I can plan with what to do with the dividend payment when it’s received. This may mean reinvesting it, using the money to pay bills or other expenditure. I simply can’t plan for such outgoings with Premium Bonds.
Another reason why I’d invest in FTSE 100 stocks over bonds is the potential upside from the share price itself. With a Premium Bond, your initial investment amount stays fixed. You don’t have risk, but you don’t have a way of growing this amount (excluding the retained income from the prize draw). With stocks, if you exclude the dividends, you can still grow the initial amount.
Let’s say you invested in a stock that had a dividend yield of 5%. Over a 12-month period, the share price could also increase 10%. Not only would you be happy about the income received from the dividend, but you’d also have 10% more from your initial investment amount! I do completely understand that this could go the other way, and the stock could be 10% down. But if you look at the long-term performance of the FTSE 100 index, this would indicate a positive return over several years. Past performance is no guarantee of future returns, but it does help us to make informed decisions.
October Premium Bond draw benefits
I wouldn’t completely discount holding Premium Bonds in your overall investment pot. If you were going to put the funds into a Cash ISA, I’d say stick to bonds. After all, you might just win big prize money in the draw. Plus at least you’re always in the running for some kind of payout. But when comparing this to dividend-paying stocks, it’s not enough for me. I’d focus much more on investments in those stocks.
jonathansmith1 has no position in any of the shares mentioned. The Motley Fool UK has 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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