Savings

Get up to 7.21% on your savings backed by the UK Treasury – ‘Bonds are back’ | Personal finance | Finance

Few savers have bothered to buy government bonds over the past twelve years because yields were low and prices high. This trend has now reversed and savers can now earn equivalent returns of up to 7.21% per annum before tax.

Gilts, short for gilded securities, are bonds issued by the UK Treasury to fund government spending.

They pay a fixed rate of interest, known as a coupon, plus a commitment to return your principal after a fixed term, mainly five, 10, 15 and 30 years.

Gilts are considered low risk because the UK government has never defaulted on coupon or principal, and are bought mainly by pension funds and other large global institutional investors, but ordinary people can also buy them.

Savers haven’t given gilts a second look in recent years as yields have fallen below 1%, giving them little return.

Yet after Chancellor Kwasi Kwarteng’s disastrous mini-budget, 10-year gilt yields soared to 5.20%.

They have since fallen back after Kwarteng reversed its decision to scrap the 45% tax bracket, but they are still earning around 4.25%, the highest in 14 years.

Previously, the government could borrow at extremely low rates, said Rob Burgeman, chief investment officer at wealth manager RBC Brewin Dolphin. “Many gilts paid a coupon of just 0.25%, and some as low as 0.125%.”

Now they are paying much more as the Bank of England is expected to raise interest rates, which will also push gilt yields higher.

The recent spike in gilt yields is bad news for the UK government as it increases the cost of servicing its huge debts, but it gives ordinary people the opportunity to generate more income from their savings.

The key thing to remember about government bonds is that when yields go up, prices go down.

Older bonds are traded in the secondary market and sellers are forced to lower prices to increase yield and attract buyers.

READ MORE: Investors pump money into gold amid fears for global economy

A gilt expiring on January 31, 2025 pays an annual coupon of 0.25%, which doesn’t sound like a great return, but there is a twist.

Each £100 bond is down to just £90.86 due to the current unrest.

Yet when the bond is redeemed, holders will receive £100.

The yield is 4.43% per year, but in practice it is worth more. Gilts are tax-efficient because even though you pay tax on the interest, there is no capital gains tax on any increase in value when the bonds are redeemed, Burgeman said.

It is also possible to buy gilts as part of your tax-free £20,000 Isa allowance and withdraw all your income and capital gains from tax.

If you do this, you should compare rates with equivalent ISA investments, as they also have the same tax advantages.

Rather than buying individual gilts, many investors prefer to buy investment funds that contain a portfolio of bonds, to spread risk.

Expert fund managers can also help you take advantage of bond price swings.

Popular funds include iShares Core UK Gilts ETF and Legal & General All Stocks Gilt Index trust. Individual bond funds and gilts can be purchased through a standard online stockbroker or trading platform.

Laith Khalaf, head of investment analysis at AJ Bell, said gilts are now “significantly more attractive than they used to be” as yields soar. “They often move in the opposite direction to stock markets, so by adding bonds to your portfolio you can reduce its volatility.”

Longer-term investors should always prioritize stocks, he said. “Measured over a 10-year period, stocks have outperformed gilts about three-quarters of the time, according to the Barclays Equity Gilt study.”

Gilts are complex and bond prices could fall further as yields continue to rise, so consider seeking financial advice before investing.