Benefits and Risks of Gilts
Investing in Gilts can diversify your portfolio and deliver predictable income. These are all great upsides, but as with all investing your capital is at risk.
Benefits of Gilts
Gilts allow investors to earn a market-leading rate of interest, which is backed by the UK government. They are less volatile than shares, and pay a fixed, predictable rate of interest.
Earn Predictable Income
Interest payments are fixed. The borrower is obligated to pay a certain amount of interest on predetermined dates. Dividends from shares however, are optional and can be cancelled by management at any time.
Most gilts pay on a fixed semiannual schedule (every six months). The interest payment schedule is set out when they’re first issued. This gives investors clarity over how much they will be paid and when. Most gilts also have a specified maturity date, so you can time your investment to coincide with your wealth planning.
Low Maintenance
Gilts are a work horse. They continually earn interest until they’re repaid. You can buy them and hold them all the way to maturity without them demanding huge amounts of time or management. They can fluctuate in price but are less volatile than stocks and shares or crypto currencies which can dramatically fluctuate by the hour and may take more time to effectively manage. Comparatively, bonds are less stressful.
Easy Diversification
Building a diverse portfolio across different asset classes and industries is a good way to diversify your risk. Although diversification does not guarantee against loss, it does minimise the risk.
You can diversify across a range of different types of gilts.
Secondary Market
Gilts can be put up for sale at any time prior to maturity in our secondary trading market. They are sold as soon as there is a buyer for them but liquidity is not guaranteed.
Gilt Risks
Gilts are an excellent asset class that have multiple qualities. However, as with all investing there is a degree of risk.
Interest Rate Risk
Interest rates and bond prices typically move in the opposite direction; so when one goes up, the other goes down. Interest rate risk is the risk that prevailing market interest rates will rise and the prices of gilts will fall.
Bond prices falling when interest rates rise may seem counterintuitive. However, consider an illustrative example:
You invest £100 in a UK gilt which has 3 years left to maturity.
If interest rates increase by 1%, investors are able to invest their money in similar credit quality assets earning 1% per year over three years.
For that reason, if you decide to sell your gilt after the interest rate increase, you will realise a lower price – about -3%, to offset its lower relative interest rate. If you choose to hold the bond until maturity you are effectively earning 1% less than bonds of similar credit risk available elsewhere on the market.
Default Risk
UK governments issue bonds because they want money to achieve a goal. There is always a risk that the plan they have for the money doesn’t pan out and they end up defaulting on their payments. It is highly unlikely that the UK government will default on its payments. It currently has a bond rating of AA, which is one less than the highest rating of AAA.
Liquidity Risk
Gilts operate in a secondary market. This means you can buy and sell them repeatedly. However, selling a gilt relies on there being a buyer. If there is no buyer then you will not be able to sell. This is a risk as there may be a lag between you putting your investments up for sale and the sale completing.