Maturing gilts: your options

I need to accumulate wealth prior to retirement

Gilts can act as a diversifier within investment portfolios and provide an income.

The nice thing about investing in gilts directly rather than through a fund is that if you hold the gilt to maturity, the overall return is known and guaranteed between the date you invest and the maturity date – assuming the UK government doesn’t default on their gilt payments that is.

This is appealing to lots of investors.

However, the 10-year gilt yield is currently around 4%. Which means if you bought a gilt today that matures in 10 years’ time, the annualised return you will receive on that bond is going to be around 4%. This return is a combination of coupon payments (interest) and capital gains.

While this is appealing, for investors looking to generate long-term growth, there are other potential options that may be more appropriate, particularly over longer time horizons.

For investors with very long-term time horizons, our view would be that shares (either held directly or via funds) are likely to be a better option for increasing their wealth, so long as the inevitable ups and downs don’t present a problem and investors are comfortable with the risk they may get back less than they invest.

For those investors who are approaching retirement or who may need access to their assets in the shorter term, holding some gilts (or bonds) definitely has its benefits.

The expected smoother return profile of the overall portfolio (due to higher levels of diversification) means that it’s less likely that if investors suddenly needed to take some of their money back, that the portfolio would have suffered a significant loss. Although as always, there are no guarantees.

For investors who receive gilt maturity payments who are in this scenario, consideration should be given to whether using the proceeds to invest in other types of asset would be more appropriate. It is quite possible though, that simply reinvesting the proceeds into another gilt may remain an appropriate investment decision too.

Investing in funds isn’t right for everyone. Investors should only invest if the fund’s objectives align with their own, and there’s a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a long-term diversified portfolio.

I need retirement income

Lots of people in retirement need income to supplement their pension. Gilts are just one of a number of different ways that income can be generated from investors’ assets.

One of the positives of investing directly in gilts for income is that, by and large, the coupon (interest) payments are fixed. This means that investors know what income they will receive during the life of the gilt. This is very attractive for people in retirement who want a specific level of income or who are managing their level of income for tax reasons.

Of course, there is the risk that the UK government defaults on their bond payments (doesn’t pay them), which might impact the coupon and maturity payments made. However this risk is a very small one, particularly when compared to the other options available.

Corporate bonds have similar characteristics to gilts, however they carry higher risk of default. This is particularly true for bonds issued by companies with lower credit ratings. These are often known as “high yield” bonds as the companies issuing them are considered more risky and therefore have to pay higher rates of interest to borrow. While they pay a higher level of income, investors need to be aware of the greater risk that these companies might default on some of their bond payments. To help manage default risk, investing in a blend of different bonds through an investment fund may be most appropriate.

The challenge with this for people in retirement is that the level of income paid by a fund is more variable. This is because the fund manager will buy and sell bonds at different points in time and will invest in bonds with lots of different yields. This means that the level of income you will receive from investing in a fund will change over time and is not guaranteed.

There is always the option of investing in shares that pay dividends as well. This can be done directly or via funds and our suggestion would be that funds are likely a better way to smooth out dividend income from a number of different companies, rather than relying on the dividend payments from just a few.

Remember that dividends are not guaranteed and could be stopped at any time, so investing for income via shares is naturally a bit more risky when it comes to knowing what the future income will be from your investment portfolio. Some markets (such as the UK) have a bias towards companies which pay dividends, which means that when considered across a lot of companies, the dividend income becomes more reliable.

Investing in funds isn’t right for everyone. Investors should only invest if the fund’s objectives align with their own, and there’s a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a long-term diversified portfolio.