𝓤𝓷𝓲𝓽𝓮𝓭 𝓝𝓮𝔀𝓼

Government bonds are back in the news after reaching yields of above 5 per cent once more. But what are they and should you be buying them?

Gilts, as they are known, are bonds issued by the UK government. When you buy a gilt, you are effectively lending money to the government for a fixed period.

In return, you usually get a fixed interest payment (called the coupon) and your original money back when the gilt matures, or expires.

This coupon payment typically happens twice a year. When the gilt then reaches its maturity date, the government pays back the lump sum it initially borrowed – which is £100 per gilt.

Gilts can make sense if you want a relatively low-risk place for your money or if you require predictable income. But they may not be the right choice if you want high long-term growth or are able to invest money over a longer period of time.

How do gilts work?

Governments issue bonds as a way of raising money. When we talk about government debt, that is partly when they issue gilts to raise funds for public spending, in areas such as to improve the country’s infrastructure.

Dan Coatsworth, head of markets at AJ Bell, says: “Many of the tax initiatives and efficiency drives won’t provide an immediate boost to public finances, which means the market is then braced for an increase in gilt issuance as a way for the government to access more funds.”

The yield is the annual return that an investor who has bought the gilt should receive. Gilt prices and gilt yields have an inverse relationship: falling gilt prices mean higher gilt yields, while when gilt prices rise, yields fall.

Suppose a gilt pays a fixed £4 annual coupon. If the gilt costs £100 then the yield is 4 per cent.

The yield – right now more than five per cent on 10-year gilts – is effectively the government’s cost of borrowing.

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Should I buy gilts and who are they for?

Kyle Caldwell, funds and investment education expert at interactive investor, says: “Gilts are lower risk compared to other bond types, due to the security of the issuer, which is the UK government. The UK Government has never yet defaulted on gilt repayments or coupon payments.”

Three groups of people in particular should consider buying gilts.

First, higher-rate or additional-rate taxpayers sitting on excess cash outside of ISAs and pensions, because the tax treatment of low-coupon gilts is hard to beat.

Their Personal Savings Allowance is £500 (higher rate) or zero (additional rate) annually, so a five per cent savings account loses most of its shine after tax – whereas a low-coupon gilt held to maturity delivers most of its return tax-free.

Second, retirees or those near retirement who want a known income for a defined period and value certainty over upside.

And third, anyone wanting to dial down the risk of a wider portfolio.

Mr Miller adds: “They are not for someone chasing growth, or for someone who needs the money in three months and cannot tolerate any price movement along the way.”

How do I buy gilts?

Investors can buy a gilt either when it is first issued or on the secondary market. If you buy a gilt when it is issued and hold it until expiry, it will be redeemed at its face value of £100. For secondary buyers, a gain or loss will depend on whether you paid above or below £100.

You can buy gilts through most major investment platforms, such as Hargreaves Lansdown, AJ Bell, Interactive Investor or Trading 212. Different platforms charge different fees for transactions and other costs.

You normally search for specific gilts by name, such as: Treasury 4.25% 2031 or Treasury 0.125% 2028. These describe the coupon and the maturity date.

Importantly, it’s possible to hold gilts inside Stocks & Shares ISAs, SIPPs and general investment accounts, so you can maximise your tax-free usage according to your needs.

That’s because while you can buy gilts within an ISA wrapper, they are also an efficient option if you’ve already maxed out your ISA allowance for the year, as profit on the price are not subject to capital gains tax. However, returns from income (the coupon) are taxable if held outside a tax wrapper.

What are the risks of buying gilts?

There is definitely a concern that the UK is borrowing too much, with overall debt high, but there’s no serious prospect it could go bankrupt.

The gilts are priced in pounds and the government can issue as many pounds as it needs to cover its debt.

Mr Caldwell says: “That said, like any savings or investments, it’s best practice to not to put all your eggs in one basket. If you do choose to invest in gilts, it should form part of your wider investment strategy as a part of a diversified portfolio.”

Alan Miller at SCM Direct added: “UK borrowing costs are at a three-decade high, and that is precisely why yields are this attractive. The market is demanding a bigger premium to lend to the government, and you, as the lender, are the one collecting that premium. The chance of an outright default is extremely low.”

There is also an interest rate risk. If rates rise further, gilt prices can fall sharply as there is less risk in simply holding cash in a bank account.

Similarly, if inflation stays high, fixed payments become less valuable as more of their value can be eroded.

Finally, there is an opportunity cost against other investments, as bonds tend to return less over time than shares, for example, which means there might be better ways to use your money over the long term.

When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.