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Your Comprehensive Guide to UK Treasury Bonds: Everything You Need to Know About Gilts

UK Treasury bonds, also referred to as gilts, can be a great way to diversify your portfolio with relatively low-risk investments.

What exactly are gilts though? And how do you go about buying them? My comprehensive guide will tell you everything you need to know about government bonds, and more.

Also consider: Your complete guide to guaranteed investment bonds UK

Key takeaways

  • Government bonds act much like a loan to the issuing government.
  • As well as paying a regular income, called a coupon, you are also given back your initial investment when it reaches the maturity date.
  • There are several different types of government bonds, such as conventional gilts, index-linked gilts, and perpetual gilts.
  • Government bonds pay varying coupon rates, which usually depend on a number of different factors.
  • You can also buy government bonds from other countries, though they may come with additional risks.
UK Treasury Bonds

What are UK government bonds?

A government bond, simply put, is a type of investment in which you loan money to the UK government for an agreed-on rate of interest.

A government – in this case, the UK government – will use bonds to raise money for things such as new infrastructure, and investors use them to earn regular interest. It is for this reason that government bonds are considered types of fixed-income investments.

Government bonds are commonly called gilts in the UK.

How do government bonds work?

As mentioned, when you buy a government bond, you are basically lending the government money for a set period of time. Investors will earn regular interest in return, referred to as “coupon payments”. This, in essence, makes them fixed-income assets.

Each bond has a different maturity period and, when this date has been reached, your bond will expire, and your initial investment will be returned to you. This is called the maturity date, and different bonds will have varying maturity dates – some may mature in one year, others in 10 or even 30 years.

How do you invest in government bonds?

When a government decides they want to raise funds through government bonds, it will issue them and typically sell them through a bond auction to banks or other financial institutions.

These banks and financial institutions will then sell these bonds on, usually to funds or individual investors.

Buy government bonds directly

You can, of course, buy government bonds directly from the government.

This would typically involve purchasing them directly from HM Debt Management Office or from authorised agents. Of course, individual bonds can still be purchased through the LSE the same way you would purchase shares in a company.

Through funds

Instead of buying individual bonds, you could also invest in them through funds.

These are typically in the form of exchange-traded funds (ETFs), which invest in government bonds for you. Instead of being given a maturity date and being paid regular interest from the government, you will instead be given a regular income through dividends.

Think of government bond ETFs as index-linked gilts. Much like how an ETF for the FTSE 100 would track the value of the FTSE and pay dividends accordingly, a government bond ETF works much the same as it tracks the value of gilts instead of you directly investing in them.

There are no coupon payments when you invest in government bonds through an ETF, and your bond doesn’t expire, though you may have to pay management fees to the fund managers.

These ETFs can be purchased through trading accounts, similar to individual bonds or shares.

What kind of bonds can you buy from the UK government?

There are several different types of bonds you can buy from the government, each with its own set of benefits. Continue reading to find out more about these different types of bonds.

Standard UK government bonds or gilts

These are the types of bonds that have been discussed previously in my article.

Standard gilts are offered by the government when they wish to raise money. Investing in them will pay a regular income in the form of interest.

The price of these may fluctuate depending on the interest rates, and they are held until a set maturity date. Once this maturity date has been reached, your original investment will be returned.

Conventional gilts

Conventional gilts are similar to standard government bonds, though these have a feature named “calls” which allows the government to pay off the debt before the maturity date.

While the coupon payments for a standard gilt may fluctuate, a conventional gilt typically pays a fixed coupon, usually twice a year.

Index-linked gilts

Unlike other types of gilts that pay a regular fixed coupon rate and then pay back your original investment when they mature, an index-linked gilt tracks the UK Retail Price Index (RPI). You can think of these as permanent interest-bearing shares.

Since a rise in inflation usually results in the Bank of England increasing interest rates, this tends to decrease the value of government bonds. This means that index-linked gilts may be better for times of high inflation.

Undated or perpetual gilts

These types of gilt usually have no set maturity date, and the government will typically pay them back at any time of their choosing.

Rather than relying on regular payments, holders of undated or perpetual gilts try to sell them for more than they paid. It is for this reason that they are typically more volatile than standard gilts.

Which government bonds are best to buy?

This all depends on your reasons for investing in the first place.

If you are looking for a lower-risk, long-term investment that pays regular coupons, then standard or conventional gilts may be better for you.

Meanwhile, if you were looking for a higher risk investment with the potential for higher returns, undated or perpetual gilts may be more suited for you.

Why would you invest in government bonds?

Even though they may seem similar to buying individual shares in a company, buying government bonds can be useful fixed-income securities that come with their own advantages.

Since countries and their governments tend to be quite stable, government bonds are typically lower risk and could offer a stable, regular investment. After all, it would require the entire government to crash for you to lose your money.

That said, you should keep in mind that this can still happen. Take Greece’s economic crash in late 2009, for example. Greece may have seemed like a stable country, but the government-debt crisis would have ruined the value of many government bonds.

So, while unlikely, it’s still possible.

Investing in government bonds could also be a great way to diversify your portfolio. Since they are linked to the government, if the market dips and the shares in your investment portfolio decrease in value, your investment in government bonds could remain stable.

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How much do UK government bonds pay?

As mentioned, you will receive your original investment when you reach the maturity date on your bond, which is called the “principal”.

Depending on the type of government bond you went for, you will also receive regular payments from the bond issuer on specific dates, called the coupon dates. You will be told the coupon dates when you purchase the bond, which tend to be annually, semi-annually, quarterly, or monthly.

When you reach your coupon date, you will be given a payment that is a percentage of the bond’s principal amount – this is called the coupon rate. For example, if your bond has a principal of £1,000, and you are paid an annual coupon of £50, your coupon rate would be 5%.

What is the current return on government bonds?

The return on your government bonds depends on the type you purchased and the time it will take to mature.

Sharing Pensions has reported that, as of May 2022, a 15-year gilt has an average return rate of 2.23%, though this can fluctuate. For example, a 15-year gilt had a return rate of 0.16% in April 2020, showing that the economy can still have an effect on the return from gilts.

You should check the return rate of a government bond before you purchase one, as they can fluctuate often.

Which government bonds pay the most?

As I have mentioned in this guide, different bonds offer differing return rates.

Hargreaves Lansdown reported that, as of 10 May 2022, the Treasury 6% government bond, which has a maturity date of 7 December 2028, offers the highest returns.

How is the pricing of government bonds decided?

There are a few different reasons the bond prices change, so keep reading to find out what these are.

Interest rates

The value of a government bond is highly influenced by interest rates. As interest rates fall, the price of a bond typically rises, and vice versa.

This is because the value of a bond is determined by the coupon rate it provides relative to interest rates in the UK.

For example, if interest rates are lower than a bond’s coupon rate, demand for the bond will increase, boosting its price. If interest rates rise above the coupon rate, however, the demand will decrease, as will bond prices.

Coupon rates

Higher coupon rates on a government bond usually mean the bond itself is worth more.

This is because the demand is typically higher for bonds with higher coupons, meaning investors are prepared to pay more for them.

Maturity times

When you first purchase a government bond, it will typically be priced according to interest rates.

As it approaches its maturity date, however, it will usually start to move back toward the face value you bought it for. This is because once the maturity date has been reached, you will be given back your original investment.

Credit ratings

All government bonds are given credit ratings by companies which aim to give you an idea of the health of a bond and are usually called an investment grade. Below are the ratings according to Standard and Poor’s:

  • AAA – The highest quality bond with the lowest risk of default.
  • AA – Still a high-quality bond with a very low risk of default.
  • A – A strong bond with a low risk of default.
  • BBB – A medium grade bond with a medium risk of default.
  • BB, B – These are speculative bonds with a high risk of default.
  • CCC, CC, C – Highly speculative bonds that still have a high risk of default.
  • D – These bonds have defaulted and are unable to pay back your debt.

Generally, bonds with BB or lower credit ratings have trouble attracting investors, so they usually offer higher interest rates. These are sometimes referred to as “junk bonds”.

When a country’s credit rating is downgraded, as are the credit ratings of the bonds they issue, meaning they decrease in value.

Inflation rates

High inflation rates usually mean that fixed coupon payments are less valuable, due to the purchasing power of the coupon payments decreasing.

Also, when inflation is high, the central bank (which in the case of the UK is the Bank of England) usually increases interest rates, which in turn typically decreases the value of the gilt.

Government bonds versus corporate bonds

Government bonds are quite different to corporate bonds. A corporate bond is when you are loaning money to a business instead of a government.

This allows a company to raise funds for projects and may allow them to obtain more money than the banks will lend them.

This is much like investing in shares of a company, though you can think of corporate bonds as interest-bearing shares.

You can then hold your corporate bond and receive interest until the maturity date. Or you can try to sell it for a profit on a secondary market, forgoing the interest payments for an immediate return.

You should keep in mind that prices and interest rates could fluctuate as the performance of a company could be less stable than a government, and the company could even fail entirely.

As a result, corporate bonds could offer a higher-risk investment that has the potential for higher growth when compared to government bonds.

What is the best dealing account for investing in bonds?

While government bonds are usually bought through an auction when the government issue bonds, you can buy some types of bonds through some trading accounts.

This is because bonds are sometimes listed on stock markets such as the London Stock Exchange (LSE). You should check whether a trading account allows you to deal in bonds, however, as some may only offer access to corporate bonds rather than government bonds.

Different trading accounts come with different benefits, so you should shop around before opening an account to find one that best suits your needs. For example, the fee structure may vary between different trading accounts.

Can I buy bonds from other governments?

You can, of course, buy bonds issued by foreign governments.

If you have a trading account that allows you to trade in foreign assets, you can buy bonds from other governments the same way you would buy gilts in the UK.

In the US, for example, bonds are called “Treasuries” and tend to be stable.

You should keep in mind that the credit rating of a country and the stability of its government usually dictate a bond’s face value.

Buying a bond in a foreign currency could also come with risks, since exchange rates change all the time, and this could eat into your profit.

What are the risks involved with government bonds?

Overall, interest rates pose the largest risk to government bonds. Since these influence the value of your bonds, a rise in interest rates would mean a decrease in the value of your bond.

Inflation also ties into this, as when inflation rates rise, the Bank of England will typically increase interest rates, further decreasing the value of your bond.

You can, however, get an interest-linked bond that will increase in value alongside inflation, which could help negate some of this risk.

UK Government Bonds FAQs

How do I buy government bonds?

To buy government bonds, you should first decide on the country and government you want to purchase them from.
When you have made a decision, you should then figure out how you want to purchase them – you can either buy them directly from the government, through retail investor accounts from a secondary market, or as a fund. You can then go ahead and make the purchase.

Are government bonds safe?

Yes, while they aren’t covered by the Financial Services Compensation Scheme (FSCS), UK government bonds are typically considered to be low-risk investments.

As with all types of investing, there is a chance that the value of your investments could decrease, meaning you could lose money.

Before buying a bond, you should ensure that the issuer is listed on the financial services register, which is a list compiled by the Financial Conduct Authority (FCA).

Please note

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension pot withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.

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