Premium bonds or ISA? What I’d choose

Christopher Ruane
·3-min read

Premium bonds have long been seen as a safe way to keep money. The capital is secure and there is the chance to win prize money every month. However, there have been changes to premium bonds which take effect next week. In effect, the premium bond odds have been cut.

Previously a premium bond had monthly odds of roughly 24,500 to 1 of winning any prize. But from December 2020 the effective odds will be roughly 34,500 to 1. I still appreciate the capital stability that premium bonds offer. But I now think a Stocks and Shares ISA can offer better returns.

An ISA can offer long-term financial stability

Unlike premium bonds, the value of shares can rise or fall. However, for many people premium bonds are a lifelong investment. They are not something I would trade. So I think a well-chosen group of shares in conservatively run companies can also offer decent financial stability over the long-term.

For example, if I set up a Stocks and Shares ISA, I would split the money across long-term stock market stalwarts such as Unilever, Diageo, British American Tobacco, Natwest, and Legal & General. In the short term, some may move up or down. But over the long term, I expect them to be broadly stable. I would also anticipate a substantial chance of capital appreciation, unlike with premium bonds.

Not only that, but my payout odds would increase dramatically versus premium bond odds! While premium bonds offer a number of very high value prizes, realistically I realise my odds of winning them are miniscule. With a diversified blue-chip ISA, by contrast, I would expect a regular, predictable income most years. Holding for the long term, I would also expect that income to increase. Diageo, for example, has raised its payout annually for over three decades. Compare that to premium bonds, whose December payout cut roughly equates to a dividend cut.

Premium bond odds could be cut again in future

One thing I don’t like about premium bonds is the fact that they don’t have to offer good returns to stay in business. Ultimately the scheme is a way for the government to borrow money long-term from ordinary investors at a low interest cost. No wonder the cut in premium bond odds has come at a time of unusually high government expenditure.

That is different to a company such as Unilever or Legal & General. They are businesses focussed on making profits and returning money to shareholders, through dividends. A dividend cut is unlikely to be made for political reasons, or because the government needs to raise funds. I don’t know what will happen to their payouts in the future. But I am confident that well-managed companies will try to make money to pay to shareholders. Over time, I expect them to increase dividends. That is different to premium bonds. I see little incentive for the premium bonds operator to increase the payout, as the latest cut to prizes shows.

A balanced portfolio can include different asset types and many people have at least some premium bonds. But I prefer to seek financial returns from a Stocks and Shares ISA. I like to feel I know what is coming, and find opportunities for strong returns.

The post Premium bonds or ISA? What I’d choose appeared first on The Motley Fool UK.

More reading

christopherruane owns shares of British American Tobacco and Legal & General Group. 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.

Motley Fool UK 2020