I’d stay away from Premium Bonds. Here’s what I’d buy instead

Many savers turn to Premium Bonds as a risk-free way to invest money. Backed by the government, these saving certificates are some of the safest investments around.

However, investors have to trade safety for returns. Premium Bonds do not offer a guaranteed interest rate. Instead, the interest rate funds a monthly prize draw for tax-free rewards. At present, the interest rate available is 1.4%. 

Even at this rate, which is not guaranteed, investors receive something of a raw deal. Inflation has averaged 2% per annum for the past 10 years. As such, an interest rate of 1.4% implies investors are receiving a real (after inflation) rate of return of -0.6%. 

In comparison, over the past 120 years, UK equities have produced an average annual return after inflation of 5%.

It’s difficult to argue with these figures. During the past century, there have been two world wars and multiple economic recessions and depressions. Nevertheless, despite these setbacks, equities have always come out on top. 

Therefore, instead of Premium Bonds, I would buy a basket of high-quality UK stocks for the long term. Today I’m going to take a look at some of the companies I would consider buying in a diversified portfolio. 

Premium Bond alternatives

The UK stock market currently supports an average dividend yield of around 3.5%. This suggests that buying a basic UK market tracker will generate a higher level of income than Premium Bonds. 

A tracker fund is one option for investors who want to try and achieve a higher return on their money. 

A diversified basket of blue-chip stocks may generate better returns over the long term though. For example, according to my calculations, a basket of blue-chip company such as AstraZeneca, Reckitt Benckiser, Unilever and Halma would have doubled the return of the FTSE 100 over the past decade. A combination of capital growth and income could have helped investors more than double their money in 10 years. 

This is the approach I would use instead of buying Premium Bonds.

That said, there are some drawbacks to buying stocks rather than the government-backed savings products. Dividends are only tax-free up to a limit of £2,000 a year. What’s more, stocks can be volatile. During the past two decades, for example, the FTSE 100 has declined by more than 50% on two occasions. 

Some investors may find this volatility challenging to deal with. However as the figures above show, despite volatility in the short term, in the long run UK equities have produced a steady positive annual return for investors. 

So, rather than seeking safety in Premium Bonds, I think investors should buy a diversified basket of blue-chip stocks.

While these investments might be more volatile in the near term, over the long run, history shows us that they’re by far the better investments. And after the recent stock market crash, now could be the perfect time to buy these equities while they trade at low levels.