Is investing in gilts the key to a golden future?

As storm clouds move over the economy, it’s hard to see any silver lining at first.

Interest rates were raised by the Bank of England to a 15-year high of five per cent on Thursday, adding further pressure to millions of mortgagees and other borrowers. Inflation remains stubbornly high at 8.7 percent, causing household budgets to become increasingly tight.

But there is one bright spot for investors looking for an income.

Investors buying UK government bonds – known as gilts – are lining up for a huge income the likes of which has not been offered since 2008.

Some gilts now pay out more than five percent. And the longer inflation and interest rates remain high, the higher government bond yields are likely to rise.

But buying UK government debt is not for everyone. Here’s how to find out if it’s right for you — and how to stick with it.

WHAT ARE GOLD PLATED EFFECTS?

A gilt is a note of debt issued by the Treasury that promises you regular interest payments in exchange for lending your money to the British government for a specified period of time. You are also promised to get back your initial investment at the end of the loan period.

The word “gilt” is short for “gilt-edged securities,” as they were originally called because the first certificates issued by the British government to bondholders had gold-plated edges.

Gilts are considered low risk because investors are almost guaranteed to get their money back. Despite a very long track record, the British government has not once defaulted on its debts. It has been issuing gilts since 1694, when King William III raised £1.2 million to fund a war with France.

The popularity of gilts has grown as returns on these historically safe assets rise. Some are now paying a higher income than can be achieved through savings accounts.

Jason Hollands, of investment platform BestInvest, says: “My message to investors who have not paid much attention to bonds in the past is that bonds are back in business and should now be back on their radar given the yields now available. ‘

However, you should research exactly what you are investing in before buying.

While the word “gilded” technically only applies to debt issued by the UK government, it is sometimes incorrectly used more loosely to describe debt issued by other countries and even by some companies that are considered highly creditworthy .

James Carthew, of investment research group QuotedData, says: ‘Banks have been slow to pass higher interest rates on to depositors, so it’s not surprising that investors are turning to the next best thing: short-dated government bonds.’

WHAT INCOME CAN YOU GET BY INVESTING IN THEM?

In general, the longer you agree to lend your money, the better returns you will be offered. As a lender, you take more risk by tying up your money for longer.

However, this rule does not always apply. Currently, gilts that mature in two years pay a yield of 5.13 percent.

The yield on a five-year gilt is currently 4.54 percent, on a ten-year gilt 4.30 percent and on a 30-year gilt 4.43 percent.

HOW CAN I GET A HIGHER RETURN?

If you want a higher, steady income from your investments, you will have to look for debt securities from other governments or companies. As a rule of thumb, the better the yield, the more risk you take.

Some investment companies that invest in corporate debt yield eight or nine percent. For example, CQS New City High Yield Fund and TwentyFour Select Monthly Income.

However, these funds often invest in companies with a low credit rating, making it more likely that you will not get your money back than with bonds issued by blue chip companies or solid governments.

Other countries also issue IOUs, although they are called differently than gilts. By comparison, however, gilts are currently among the best-performing among other stable governments.

The US government sells Treasuries. These currently yield about 3.8 percent on debt maturing in ten years. The German government has bunds; these yield 2.5 percent for debt issued over ten years.

WHY ARE DEBT RETURNS RISING?

The rate of return the UK government pays on its debt is determined by how much it has to offer to convince investors to buy it.

When interest rates rise, investors need more persuasion to buy gilts. That’s because higher rates mean investors can get better and better income simply by leaving their money in a savings account as cash — they don’t have to invest it at all.

The greater the perceived risk of a borrower defaulting, the more he must pay to lenders to assume his debt. Therefore, in times when a country or a company is struggling, or when investors lack confidence in the people at the helm, their cost of issuing debt rises.

However, in the case of UK and other strong governments, credit risk has a very modest impact on the price of debt simply because they are seen as such reliable borrowers.

WHAT ARE THE RISKS OF MONEY IN GILTS?

When the yield of gold-plated bonds rises, their price falls. That’s good news for investors buying gilts now, as they are very cheap. But it’s not so good for investors looking to sell existing gilts. If the returns continue to increase, if you later decide to sell your gilts, the price you get for them will be less than the price you paid for them.

When buying debt there is always the risk that the issuer will simply not be able to repay you and you will lose your investment.

This is extremely unlikely with UK government bonds, but other governments, such as Argentina, Lebanon and Ukraine, have defaulted, causing investors to lose money. Be aware of the risk when buying government or corporate debt.

A good way to measure risk is to look at ratings from specialized rating agencies such as S&P, Moody’s and Fitch. These estimate the risk of default for lenders, rating them from AAA – the safest – to BBB and even D for some agencies.

You can manage your risk level by only purchasing debt with ratings you are comfortable with. If you decide that gilts are right for you, they should only be part of your portfolio, along with other types of investments, so you don’t have all your eggs in one basket.

While government bond yields have increased, they are not moving faster than inflation, so if you have all your money in government bonds, it will depreciate over time.

However, it is difficult to find investments that are faster than inflation right now. Any gilts that do are likely to be at significantly higher risk than gilts.