Here’s the easy, no-fuss way to invest in gilts. Oh, and in case you were wondering what exactly they are, we’ve explained that as well. Read on and get step-by-step instructions.
Gilts are government bonds – they’re loans to the government. Just as you or I might go to a bank to raise a loan for a car or a mortgage for a house, the government comes to us, en masse, to raise some cash to spend on sensible things like trips to Brussels, bailing out bankrupt banks and buying nuclear warheads. They are similar to corporate bonds except they are raised by entire governments rather than companies.
In return for this very kind loan from you, the government promises to pay you interest for every year you loan them this money.
As with so much in the world of investing, the whole ‘risk and reward’ principle very much applies to bonds – including government bonds (gilts). If you’ve ever tried to borrow money from banks you’ll have noticed that lenders will first try and calculate whether you’re good for the loan or a bit of a dodgy customer.
They’ll do a credit check on you first. If they think they have a good chance of getting their money back from you they’ll offer you a nice low interest rate. However, if they think you could potentially default they’ll cover themselves by insisting on a high interest rate so they can rake in a hefty wedge of cash early on before you do the dirty on them.
It’s the same in reverse when you invest in bonds. You’re the one lending to them so you want to know how good the governments or companies you lend to are for the loan. Some (particularly certain companies) could be very risky so they offer a quite high rate of return. Although you could potentially lose it all, of course.
Others, like nice, safe European governments such as our own, are pretty solid (I know they don’t seem it but check out many other governments in the world), so they only offer a low interest rate. However, you can be pretty safe in the knowledge that you’ll get your cash.
Who should buy gilts?
Gilts are good for those who are looking for a very safe, fixed income. They’re also helpful if you are looking for something stable to add to a more adventurous set of investments.
Gilts are useful and sensible for people who have retired and want a fixed income. They’re also an option for those who already have a lot of other sexier investments and would like something solid to underpin their portfolio.
But for young investors, unless you’re the sort who likes to wear two pairs of pants ‘just in case’, you should look on them as something to know about for later.
Still interested? Read on!
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When you buy a gilt you’re effectively lending money to the government and it promises to pay you a certain amount in interest each year for that loan. The interest is usually fairly low and can look very low relative to the rates you could get on savings bonds.
However, right now gilts look rather good because the Bank of England base rate is so low that the interest we get on ordinary savings is pretty pathetic. Also, unlike savings bonds, which normally last for one to five years each, government bonds can last for decades.
Most gilts are issued for a fixed period of several years. What are called short-dated gilts are those with a period of up to five years before redemption (the date at which you are repaid), medium-dated are for those between five and 15 years and above 15 years the gilt is known as long-dated. However, you don’t have to keep them for all that time. You can buy and sell them on the open market at any time.
There are also what are called ‘undated gilts’. Undated gilts, as the name implies, are designed to carry on paying interest forever, without ever being redeemed. However, you have to be a bit careful with them, since they’re not actually as undated as they sound and some could actually get redeemed in due course. They tend to have low interest rates and therefore their price tends to be quite a lot lower than £100.
Because gilts last such a long time, if you’re thinking of buying into them you have to consider how you think the Bank of England interest rate will move in the future. This is because you could get a nice regular income simply by putting your money into savings accounts with banks or building societies.
If you think base rate is likely to go up and stay up for a while then you could be better off putting your money into savings accounts. However, if you think interest rates could generally go down then a long-term gilt would be a good buy.
The price of gilts
Gilts have a specific price at which you buy them, and that price is generally related to how impressive their interest rate seems at the time.
If basic Bank of England interest rates are low, the rates on bonds will look good so the price of gilts generally will be higher – in other words you pay a premium, more than ‘par’ (face value). This means that what you actually make overall on the bond (the amount it all adds up to when
the term of the bond ends) will go down. However, if basic Bank of England interest rates go up then bond rates will look unimpressive so their price will fall (it will be sold ‘under par’) and therefore their overall bond yields will rise.
For example, a bond with a face value of £100 might sell for £105, meaning at a £5 premium. Or, you might find a bond of £100 value selling at £95 meaning you bought at a discount.
When you come to redeem these gilts – in other words, when they come to the end of their terms – you’ll redeem them at £100. So if you bought them at £95 you’ll make money on the sale, if you bought them at £105 you’ll lose some. It’s important, then, to make sure that bonds you buy ‘above par’ have enough of an interest rate payment each year to more than make up for the loss you make at the end.
How to work out how much you’ll make
There are two main things you should consider if you buy gilts:
1. The price of the gilt (per £100-worth) and
2. The coupon (interest rate) being offered.
If a gilt is offering a low interest rate, relative to average rates for savings accounts, it’s likely to be selling at a discount. So you could find that you only have to pay, say, £96 for £100-worth of a particular gilt. Or if the gilt’s interest rate is looking rather attractive it might be selling at £106.
It’s a choice for you – do you want to have the capital growth or do you want to have the higher interest payments?
You can invest as little as £1 in gilts but people generally buy them in multiples of £100 which is how they are displayed in the boring-looking columns in the financial pages of broadsheet newspapers. So, for example, if the government wanted to raise £1 billion to be repaid in 2025 with a fixed interest rate of 4.5% they would issue gilts called something like ‘4.5% Treasury 2025’.
Don’t forget inflation
Given that the interest rate of gilts is fixed – often for a long time (it could be decades) do you think that it will cover inflation and beat average savings rates over that time? The longer your gilt lasts, the more of a gamble it is as no one can see into the future and no one can accurately predict the movements of interest rates over time.
You can get index-linked gilts where the interest paid and the redemption amount rise in line with inflation. In fact, it’s not quite as good as this, because they lag inflation by three months. However, they can be a good option if you’re planning on keeping your gilts for many years – the longer you keep a fixed-income investment the more it is affected by inflation.
Still, index-linked gilts, not surprisingly, tend to offer a lower interest rate than the fixed ones. Again, it’s a gamble you have to consider and there are no definite answers. You will need to get your calculator out, work out the difference over time (assuming at least 2.5% inflation each year). If you’re looking for low risk in your investments, it probably doesn’t get much lower than this.
You can either buy gilts directly or you can invest in gilt funds.
On the whole it’s best to buy gilts direct rather than doing it through a fund. That way, not only do you avoid paying a management fee (the fund managers like to take their pound of flesh before putting your money to work) but also if you hold actual gilts you don’t pay capital gains tax on them.
Occasionally, the government has new gilt ‘issues’, and they’re often sold direct to the public either at a fixed price or by tender or auction. You can find out about forthcoming issues at the website of the government’s Debt Management Office (DMO). The advantage of buying a new issue of gilts is that there’s no dealing commission, which you would have to pay if you buy ’second-hand’ gilts (from other people) so that cuts down on your costs.
However, there are a few hoops you will need to jump through first:
- You need to apply and register with Computershare, an outsourced agent of the government’s Debt Management Office.
- You need to be accepted onto the Approved Group of Investors before you can start buying up government gilts. (This is to verify things like your basic identity and your sources of funds).
You can however also buy gilts through most stockbrokers, just like you can buy shares. You don’t usually need to join the Approved Group of Investors using this method – though the stockbrocker will have their own checks.
It used to be the case that you could buy gilts through the Post Office or direct from the Bank of England but you can’t any more, which is a shame as buying through the Post Office seems a nice, easy way to do it.
We suggest you set up an online stockbroking account – an execution-only service – just as you would for buying shares. It’s free to register with them and you don’t have to buy anything immediately once you have your account. You can join now and wait for months before you invest in anything. However, once you do trade it will be very cheap to buy and sell gilts and you’ll have constant access to your investments.
We like TD Direct Investing. They’re cheap (just £5.95 per trade) and straightforward to use although you’ll have a few online forms to fill in. Here’s how you join:
1. Go to the homepage and click on the ‘Choose an account’ button. A new window will open displaying a range of account types. Choose one and clicked on ‘Apply online now’.
2. You’ll then have to confirm that:
- You’re a private individual aged 18 or over
- You’re a UK resident
- You’re a British national
3. Then you’ll need:
- Your address details for the past three years
- Your debit card details
- Your National Insurance number
4. The page after this information will ask for your country of residence, whether you have an existing TD Direct Investing account number and what kind of account type you want (we suggest a basic trading account to start off with). Your password can be delivered by post or email. You’ll also have to say whether you work in the financial services industry and whether or not you need to submit copy contract notes to your employer.
5. The next page asks what type of, for example, ISA you’re looking for and it explains something about the differences in their accounts. They go on to explain their responsibility to your personal information.
6. There follows a few pages that you have to fill in with your personal information. They’ll want your debit card details in order to protect against fraud, where you work (and how long you’ve been employed there) along with your home address and tenancy status. After filling in all these pages they’ll thank you and get back to you within 48 hours confirming whether or not they can trade with you.
7. Once you have an account, you can credit it with a money transfer and then use it to invest it in some gilts.
There – that didn’t hurt did it?