Get up to 7.21% on your savings backed by HM Treasury – ‘Bonds are back’ | Personal Finance | Finance
Few savers bothered buying government bonds in the past dozen years as yields were low and prices high. That pattern has now gone into reverse and savers can now get equivalent returns of up to 7.21 percent a year before tax.
Gilts, short for gilt-edged securities, are bonds issued by HM Treasury to fund government spending.
They pay a fixed rate of interest, known as a coupon, plus a pledge to return your capital after a set term, primarily five, 10, 15 and 30 years.
Gilts are seen as low risk because the UK government has never defaulted on the coupon or capital, and are bought mostly by pension funds and other big global institutional investors, but ordinary people can buy them too.
Savers haven’t given gilts a second glance in recent years as yields fell below one percent, giving them little return.
Yet after Chancellor Kwasi Kwarteng’s disastrous mini-Budget, 10-year gilt yields shot past to 5.20 percent.
They have since retreated after Kwarteng reversed his move to scrap the 45 percent tax band, but still yield around 4.25 percent, the highest in 14 years.
Prior to this, the government was able to borrow at extremely low rates, said Rob Burgeman, senior investment manager at wealth manager RBC Brewin Dolphin. “Many gilts paid a coupon of just 0.25 percent, and some as low as 0.125 percent.”
Now they pay a lot more as expectations rise that the Bank of England will hike interest rates, which will also force up gilt yields.
The recent surge in gilt yields is bad news for the UK government as it increases the cost of servicing its huge debts, but it gives ordinary people an opportunity to generate more income on their savings.
The key thing to remember about government bonds is that when yields rise, prices fall.
Older bonds are traded on the secondary market and sellers are forced to lower prices to bump up the yield and attract buyers.
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A gilt expiring on January 31, 2025, pays an annual coupon of 0.25 percent, which does not look a great return but there is a twist.
Each £100 bond now costs just £90.86 due to current turmoil.
Yet when the bond is redeemed, holders will be paid £100.
The return is 4.43 percent a year but in practice it is worth more. Gilts are tax-efficient because while you pay income tax on the interest, there is no capital gains tax on any rise in value when bonds are redeemed, Burgeman said.
It is also possible to buy gilts inside your tax-free £20,000 Isa allowance and take all of your income and capital gains free of tax.
If you do this, you should compare rates against equivalent ISA investments, as they also have the same tax advantages.
Rather than buying individual gilts, many investors prefer to buy investments funds that contain a portfolio of bonds, to spread risk.
Expert fund managers can also help you take advantage of shifts in bond prices.
Popular funds include iShares Core UK Gilts ETF and Legal & General All Stocks Gilt Index trust. Both bond funds and individual gilts can be bought via a standard online stockbroker or trading platform.
Laith Khalaf, head of investment analysis at AJ Bell, said gilts are now “significantly more attractive than they were” as yields soar. “They often move in the opposite direction to stock markets, so by adding some bonds to your portfolio, you can reduce its volatility.”
Longer term investors should still prioritise shares, he said. “Measured over a 10-year period, shares have outperformed gilts around three quarters of the time, the Barclays Equity Gilt Study shows.”
Gilts are complex and bond prices may have further to fall as yields continue to rise, so consider seeking financial advice before investing.
