With UK Government Bond (gilt) yields rising in recent months, investors are increasingly looking at how they can use gilts within their portfolios.
A ‘gilt ladder’ has potential to help investors manage future cashflows, and higher yields only add to their appeal. We’re looking at what a gilt ladder actually is, why an investor might want to use one and what to consider when building one.
This article is for information only and not personal financial advice. Investing can help your money grow, but the value of investments can rise and fall, so you could get back less than you put in. Yields are variable and not guaranteed, and past performance isn’t a guide to the future.
Investing is for the long term, typically 5 years or more. If you’re not sure what’s right for you, a financial adviser can help.
What is a gilt ladder?
A gilt ladder is when an investor buys several individual gilts that mature at different times over a specified period in the future. Each individual gilt acts as a rung on the ladder.
Gilts largely have fixed returns, meaning that at the point of purchase, an investor knows what coupons (interest payments) and maturity values (lump sums) will be paid, and when.
This is very useful for investors who have specific cashflow needs because it’s relatively easy to understand what cashflows the portfolio of gilts will provide.
Want to check your knowledge of gilts? Read our article on what you need to know about buying government bonds (gilts).
A basic example:
Gilt | Number of gilts bought | Price per gilt | Annual interest per gilt (coupon) | Maturity date | Maturity payment per gilt |
|---|---|---|---|---|---|
1 | 2 | £98.20 | £4.88 | 31 March 2028 | £ 100 |
2 | 2 | £100.36 | £5.00 | 07 December 2030 | £ 100 |
3 | 2 | £93.27 | £2.63 | 22 April 2032 | £ 100 |
4 | 2 | £93.82 | £3.50 | 31 July 2034 | £ 100 |
5 | 2 | £108.63 | £7.00 | 16 November 2036 | £ 100 |
In this example, the total investment would be £988.56. Initially the investor would receive annual interest payments of £46 (the total of all the coupons for every gilt bought).
Then, on 31 March 2028, the investor gets to the first rung of the ladder. They receive a maturity payment from Gilt 1 of £200 and the annual interest payments from then on would reduce to £36.25.
The investor can choose what to do with the £200. It might be they use it to buy another gilt, annuity, or dividend-paying fund or shares, put it in a savings account or take the cash to supplement their income. This flexibility is one of the key benefits of using a gilt ladder.
Why use gilts and not corporate bonds or other forms of fixed return investments?
The returns on gilts have historically been very reliable and following the recent increase in yields they’re attractive compared to other forms of low-risk investment like cash at the bank.
An advantage of using gilts is that there's no capital gains tax payable when invested in directly. For gilts where the coupon is small, much of the return will come from a capital gain. For investors buying gilts outside of a tax efficient wrapper like a Stocks and Shares ISA or a Self-Invested Personal Pension (SIPP), this makes gilts potentially more appealing.
But if you hold gilts within a Stocks and Shares ISA, they're already free of UK tax on both income and gains. The same applies to gains within a SIPP, though remember that income drawn from a pension is taxed at your marginal rate.
Investors should consider tax implications of holding different assets and using different wrappers like ISAs or SIPPs. Tax, ISA and pension rules can change and benefits depend on circumstances.
Another reason to use gilts over corporate bonds is that the market for gilts is bigger. This means that if there’s a need to cash in the investment portfolio, it should be relatively easy to do. It’s important to note that gilts are investments and prices fluctuate, so if the investor sells a gilt before its maturity date, they could get back less than they invested.
Why would an investor want to use a gilt ladder?
Gilt ladders are a great way to manage future cashflow needs because the coupons and maturity payments are fixed. There are lots of different reasons that an investor might find this appealing.
It could be to pay annual school fees as they become due or to cover the cost of the regular holidays. For the self-employed, where income could be lumpy as projects are completed, having the comfort of receiving interest and lump sum payments for key spending points over the year, like Christmas, might be useful. And for those in retirement, a gilt ladder is a way to diversify where their income comes from.
For younger investors though, or those more comfortable with the potential for losses, while fixed income can be part of a portfolio, it’s important to remember that over the long-term, a diversified shares portfolio tends to offer the best real returns.
What to consider when building a gilt ladder
Everyone’s circumstances are different which means any gilt ladder needs to be tailored to the individual investor’s needs.
Some potential things for investors to consider
The amount of capital available to invest
Smaller amounts might mean fewer rungs of the ladder with maturities not too far into the future
Larger amounts might mean more gilts that could mature a long way into the future
Whether there’s a preference for higher interest payments or capital gains
This will impact gilt selection and the resulting maturity dates
Interest payments on individual gilts range from 0.125% to 6% per year
At what points in time income is needed in future
Perhaps a large lump sum is required in three or five years’ time, which could mean investing a bigger proportion into a gilt that matures at that point, rather than spreading it out equally
Whether income needs increase or decrease
If income needs increase over time, it might be suitable to invest a larger proportion in gilts that mature further into the future compared to those that will mature sooner – this would lock in bigger lump sum payments in future
Other points to note:
Coupons (interest payments)
They’re usually paid twice a year by individual gilts. Payment dates are normally the same as the maturity date and the date 6 months later.
For example, if a gilt has a maturity date of 31 January, it’ll usually pay coupons on 31 January and 31 July each year until maturity. The amount of each payment is equal to half of the annual coupon percentage.
‘Strips’
There are currently three UK Treasury Strips available, which do not pay any coupons. All returns from these are treated as income for tax purposes, so the capital gains tax exemption does not apply.
Bonds with longer periods of time until they mature
These have a higher duration. This means that they are more sensitive to changes in interest rates (or changes in expected future interest rates).
If investors buy and hold gilts to maturity, this volatility doesn’t impact the returns received. The risk is that if the investor has to sell the gilts before maturity, it’s possible that the investor could get back less than they initially invested.