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

As interest rates have increased, so has the interest in government bonds (gilts). But what are gilts, how do you buy them and should you invest in them?

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

Read our latest article on this topic: Most bought gilts in August 2023

As interest rates have increased, so have the yields on government bonds (gilts). At the start of this week you could get 4.94% on gilts that have one year until they’re redeemed. That’s higher than the interest on lots of bank accounts, with no fixed-term strings attached.

This is sparking the interest of many investors. But how do gilts work and what’s the case for (and against) owning them?

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, you’re lending money to the UK government in return for regular interest, and you get the amount you lent to them back when the bond matures. Just like other bonds, the borrower (in this case the UK government) promises to pay back the loan at a fixed date and to pay interest in the meantime.

When interest rates change, the price of a gilt tends to change too – if interest rates go up, gilt prices usually fall, but that means the yield then goes up.

Government bonds are typically viewed as the ‘safest’ form of bond. That’s because a government usually has control of its currency, so can print more money to pay back investors if it needs to.

How do gilts work?

Gilts are normally issued at a price of 100p per unit, which is known as the par value.

They usually have a date which is given in the name of the gilt when the par value will be repaid in full.

Gilts pay interest – this is given as a percentage of that 100p, which is known as a coupon. This is the amount of income you get each year.

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.

As gilts are traded, they can be bought and sold below or above the price at which they were issued at. The amount of income based on what you pay is known as the yield.

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 rises, the price of gilts tends to fall. That’s because the interest on offer won’t now look as attractive as when rates were lower.

If higher interest rates cause bond prices to fall, that also means the yield increases – what you get as a percentage of the price you paid. That means the price and the yield on a bond move inversely – as one rises, the other falls and vice versa.


Why are gilts interesting?

There’s always a place for bonds and gilts in a well-diversified portfolio. But thanks to rising interest rates, investors have started to sit up and take notice of them again.

When interest rates rise, gilt prices tend to fall. And that’s when things start to get interesting.

Firstly, if a gilt’s price falls, its income yield rises. And if the price of a gilt falls below its par value (100p), 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.

The total of the income and capital return can be higher than what you’d get from many easy-access bank accounts.

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.

If you hold gilts in an ISA or Self-Invested Personal Pension (SIPP), you won’t pay any UK income or capital gains tax on them at all.

You should remember that tax rules can change, and benefits depend on your individual circumstances.

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 2025. In 2 years the government will repay the capital at 100p per unit meaning you would get:

Income return Capital return Total return
£12.50 £85.30 £97.80
1.37% 9.32% 10.69%

So for this gilt, that 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 get different ratio between income and capital returns.

What should you be aware of?

You’ll pay dealing commission to buy a bond or gilt, and if you decide to sell it before it redeems. This will eat into your returns. With us, this starts from £11.95 for online trades and is 1% (minimum £20, maximum £50) if you trade over the phone or by post.

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 and the cost of the bond.

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

You could get better investment performance

While gilts are as ‘safe’ as you can get when investing in bonds, they don’t always offer the highest returns for that very reason.

Inflation is currently at 7.9%. As you can see from the latest UK gilt yields on offer, it’s not enough to beat inflation and give you a ‘real’ return – but that doesn’t mean gilts should be ignored. Gilts can play a valuable role in diversifying any investment portfolio and shouldn’t be overlooked.

Find out more about diversification

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.

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

What’s next for bonds in 2023? – Expert views from HL’s fund managers

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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