British government bonds, also known as gilts (short for gilt-edged securities) are simply IOUs issued by the British government to raise money to cover expenditure that isn’t covered by tax revenues and other sources of government income. When an investor buys a government gilt they are simply lending their money to the UK government. This IOU will have a term and at maturity the full sum originally invested by the investor will be returned in full.
Why lend money to the government?
As long as you hold the bond you are paid interest, or what’s more commonly known as a ‘coupon’. This coupon is paid semi-annually as a return for lending your money to the government. This coupon is a fixed percentage of the original amount invested.
So, for a £20,000 ten-year bond with a 5% coupon bought at face value (par) an investor would receive £1,000 gross each year in interest and at maturity receive their initial investment of £20,000 back.
How safe is a UK government gilt?
There is very little risk that you could lose your money if you invest in UK government gilts. The Treasury guarantees interest payments and that your loan will be repaid in full at maturity. UK Gilts are highly secure as the UK government has never defaulted on its debt.
Similar to corporate bonds, government gilts can also be bought and sold and their prices will change according to the market. So, if you hold a ten-year government gilt you don’t necessarily have to wait ten years to cash-in the bond. You could sell it at any point and generate a profit or loss depending on whether the price of the bond has risen or fallen at any given moment in time.
No asset class can truly provide a complete solution in every economic environment. At Raymond James we believe that all portfolios should have a mix of assets, depending on your medium and long-term objectives and appetite for risk. Gilts can be a critical part of this mix as the part of an investor’s portfolio that aims to produce a better medium to long-term return than cash, without the volatility of equities.