With interest rates on cash balances being exceptionally low, many people may invest £20k (or any other amount) in Premium Bonds to try and make a million.
For a small number of people, this will be a successful strategy. However, the vast majority of Premium bondholders obtain a return that is far less than £1m. In fact, the annual prize rate is currently 1.4%. This is essentially the same as the return on cash balances.
As such, there may be a more effective means of making a million that can be implemented by anyone with a long-term horizon.
Return potential
The stock market’s track record of returns is more impressive than other mainstream assets. For example, since its inception in 1984 the FTSE 100 has recorded annualised total returns of around 9%. This means that it has taken just eight years for an investment in the index to double, on average.
Looking ahead, a similar rate of return could be on offer. The FTSE 100 currently yields 4.5%, which is above its long-term average. This suggests that it offers good value for money, and may be able to post impressive levels of capital growth. Furthermore, with the index generating the majority of its income from outside the UK, it could benefit from rapid growth rates in emerging economies.
When compounded, a 9% annual total return could produce a £1m portfolio surprisingly quickly. For example, a £20k investment would take 46 years to reach a £1m valuation. With additional contributions, you could reach that goal significantly faster.
Risk profile
Of course, the FTSE 100 does not return 9% every year. There are periods of severe negative returns that could cause your investment to halve – or worse. However, such periods have only ever been temporary, with the FTSE 100 having successfully recovered from every bear market it has experienced to post new record highs.
Therefore, the key for any investor is to have a sufficiently long time period for a recovery from downturns to take place. In such a situation, paper losses should not be a major concern. Rather, they may present buying opportunities which can be used to capitalise on lower valuations across the index.
Starting today
Investing in FTSE 100 shares is now easier than ever. Opening an online share-dealing account can be done in a matter of minutes, with funding an account possible instantaneously via debit card.
Diversifying across a number of shares is crucial for any investor. It reduces overall risk, and can lead to improved returns in the long run. For investors looking to diversify with modest capital, a tracker fund that aims to follow the index’s performance could be a worthwhile idea.
However, with the cost of share-dealing having fallen in recent years, building a diverse portfolio of FTSE 100 shares is cost-effective for many investors. Doing so could lead to higher returns than Premium Bonds, as well as a higher chance of making a million.
