What you need to know about buying government bonds (gilts)

This article isn’t personal advice. If you’re not sure whether an investment is right for you, ask for financial advice. All investments and any income from them can fall as well as rise in value, so you could get back less than you invest.

Investing in individual gilts isn’t right for everyone, you should only invest in gilts as part of a diversified portfolio.

What is a gilt?

A gilt is a UK government bond. When you buy one at issue, you’re lending money to the UK government in return for regular interest. They then give the amount you lent to them back when the bond matures (ends).

Just like other bonds, the borrower, in this example the UK government, promises to pay back the loan at a fixed date and to pay interest in the meantime.

UK Government bonds are typically viewed as one of the ‘safest’ forms of bond. That’s because the government usually has significant influence over its currency, so can print more money to pay back investors if it needs to.

How do bonds (including gilts) work?

The key factors of bonds, such as gilts, can be broken down as follows:

• Issuer - This is the entity which is borrowing the money – i.e. the government, company or other organisation.

  For instance, if £500 million will be borrowed, £500 million of securities will be issued by the issuer. Typically, these will be launched at "par" (face value) or £100.

• Coupon – The rate at which the issuer will pay interest.

  The issuer commits to pay a rate of interest of "X"% per year. This coupon will generally be a fixed amount and is paid annually or semi-annually. For example, if you bought one unit of a gilt when issued at 100p per unit, that paid a coupon of 5%, you’d get 5p every year.

• Maturity – Date the loan will be repaid.

  A date is set for the repayment of the money, known as the maturity or redemption date. The bonds are usually redeemed at "par" or face value of £100 (with some rare exceptions).

As gilts are traded, they can be bought and sold below or above the price at which they were issued at.

Perception of whether the gilt can be repaid moves the price, but it also depends on the interest rates central banks set. When the base interest rate changes, the price of a gilt tends to change too.

Gilt prices and interest rates have an inverse relationship:

• if interest rates go up, gilt prices usually fall, but that means the yield - what you get as a percentage of the price you paid - goes up. That’s because the interest on offer is no longer as attractive as when rates were lower.
• if interest rates fall, gilt prices usually rise. This is because newly issued gilts will offer lower yields than existing gilts. This will increase demand for the existing higher-yield gilts, raising their price.

LEARN MORE ABOUT GILTS AND BONDS

Why are gilts of interest to investors?

There’s always a place for bonds and gilts in a well-diversified portfolio and their popularity with investors tends to rise along with interest rates.

As mentioned above, when interest rates rise, gilt prices tend to fall.

If a gilt’s price falls, its income yield rises. And if the price of a gilt falls below its par value (£100), you’ll get a government-backed capital return if you hold it until its maturity date. Though a capital loss is still possible if you sell before maturity, or if the government defaults.

Secondly, there’s a big tax benefit too.

The tax advantage of holding gilts

There are two types of return when you invest in gilts. The income and any capital gain. Each element is taxed differently for private investors.

Interest paid by a gilt is taxed as income.

Any capital gains, however, are tax free. If you sell at a capital loss this can’t be used to offset other gains. You also don’t pay any stamp duty or stamp duty reserve tax when you buy a gilt.

Example 1:

Here’s an example based on buying 1,000 units of a gilt trading at 91.5p each, with a nominal interest rate of 0.625% and set to mature in two years’ time. At the time of purchase, this would cost £915. In two years the government will repay the capital at 100p per unit meaning you would receive £1,000 in exchange for your 1,000 units.

For this gilt, it works out at over 5% annual return, excluding any dealing commission. Most of this return comes from capital gains rather than income.

Of course, each gilt is different and investors could get a different ratio between income and capital returns.

Example 2:

Here’s an example of a gilt with a higher coupon, where most of the return is issued as income rather than capital.

An investor buys 1,000 units of a gilt with a nominal interest rate of 2.5% which is set to mature in two years’ time. The gilt is currently trading at 99.5p per unit, meaning that 1,000 units would cost £995 (excluding dealing charges).

You will receive a coupon payment of £25 per year or £50 over the two-year period. At maturity, the government will repay the capital at 100p per unit meaning you would receive £1,000 in exchange for your 1,000 units.

For this gilt, it works out at over 2.7% annual return, excluding any dealing commission. Most of this return comes from income rather than capital gains.

For more details on the calculations used to work out income and capital return on a gilt, head to our learn about bonds page.

What should you be aware of?

Gilts, due to generally being perceived as low risk, offer lower returns than other assets. You could get better performance from investing in a corporate bond or other asset although these can be higher risk.

If you’re considering investing in gilts, be sure that you are maintaining a level of diversification in your overall portfolio that suits your investing goals.

Diversification means spreading your money between different types of investment. Whether it’s types of companies, types of asset - like shares, gilts, bonds, funds and property - different parts of the world, or investment styles, there are lots of ways you can do it. Find out more about diversification.

By investing in a gilt, you’re almost guaranteeing what you’ll get back if you hold to redemption. Similar to holding a fixed rate savings account. An investment in shares could provide a higher return, although there's a greater chance you'll lose money too. All investments fall as well as rise in value so you could get back less than you invest.

You should always check the real return of your investments. Depending on the market, the returns offered might not be enough to counter the impacts of inflation.

As with any investment, you should know how dealing charges will impact your returns.

You’ll typically pay dealing commission to buy a bond or gilt, and if you decide to sell it before it redeems. With HL, this is £11.95 for online trades and is 1% (minimum £20, maximum £50) if you trade over the phone or by post. Note, some government bonds can only be traded by phone.

You’ll also need to pay the accrued interest to the seller of the gilt as part of the trade. This is the amount of interest the gilt is determined to have built up in between the payment dates for income.

This is standard practice in the bond market and strikes a fair balance between buyers and sellers. It also neatly helps differentiate between cash flows from income and those from capital gains.

What is ‘clean’ and ‘dirty’ pricing?

When you’re buying a gilt, it’s worth noting the difference between what’s known as the ‘clean’ and ‘dirty’ price.

The clean price is the price of a bond not including any accrued interest. This is the price that’s normally quoted on our website.

The ‘dirty price’ is the price of a bond that includes accrued interest between coupon payments.

If you buy a bond immediately after issue or the most recent coupon, the clean and dirty prices will be the same.

However, if you buy partway through a coupon period (they’re typically paid twice a year), you’ll need to account for adjustments that reflect income accrued to the bond. This means the actual price you pay will include accrued interest as well as the cost of the bond.

In practice, once you’ve bought the gilt, it will reflect as a ‘loss’ on your account – this is simply because the accrued interest was not reflected in the value shown.

How to invest in gilts

You can buy individual gilts with us and hold them within any of our investment accounts.

While many are available to buy and sell online, some will need to be traded over the phone by calling our dealers.

Find out more including charges

See latest Gilt prices

If you’re looking to hold gilts as part of a smaller portfolio, funds can be a great way to do it.

You can start investing in a fund from £25 a month as a direct debit or £100 as a lump sum.

Unlike holding gilts directly, funds that invest in gilts can be subject to capital gains tax.