A bond portfolio may secure income close to 6%. Given that, why risk a stock-market sell-off?
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Why risk a sharp stock-market fall when a bond portfolio can provide income close to 6%? More ordinary UK investors are reaching that conclusion. Hargreaves Lansdown says the number of users holding individual gilts - UK government bonds - rose 38% year on year.
The sharp rise in government bond yields has hit long-dated debt hardest. The 30-year gilt now yields 5.94%, but that figure may mislead investors: as James Baxter of Tideway Wealth points out, the government has steered clear of issuing new debt at rates that high.
Instead, you would need to buy an older gilt with a lower coupon - one now selling below its par value. The maths are a little fiddly, but the point is simple: part of that tempting 6% return comes from the bond's price rising to par when it matures, perhaps in 2055. Most of us will be elderly by then.
The UK's public finances may look bad enough to suggest a default risk, but that is not a realistic prospect: the Bank of England can always print more pounds. Bond buyers face different dangers - rising interest rates can send secondary-market prices down, while inflation eats into the real value of fixed-income payments.
Are index-linked gilts (linkers) really a good answer to inflation risk? Christian Mayes of Morningstar is doubtful. Their maturities are usually longer than those of nominal gilts, which makes them more exposed to rising interest rates. That showed up clearly in 2022, when higher rates hurt linkers more than their inflation protection helped.
A niche strategy for bonds
Gilts have regained attention partly because of a specific tax advantage. Coupon payments are taxable outside an individual savings account (ISA), but gilts are exempt from capital gains tax (CGT). Short-dated bonds selling well below par can therefore look appealing. Anna Macdonald of Hargreaves Lansdown points to a 0.125% coupon bond priced at 94.78, with maturity due in January 2028. Its yield to maturity is 4.2%, most of it tax-free. For higher-rate taxpayers who have used their other allowances, these gilts offer a relatively low-risk home for spare cash - especially with so much talk of stock market bubbles.
But buying gilts has a cost: investors who favour them may be overlooking better-value opportunities in the stubbornly cheap UK stock market. Income seekers can reasonably prefer the ten-year gilt to the FTSE 100's 3% dividend yield, yet the comparison changes when earnings are considered. At 7.4%, the FTSE 100's earnings yield - the inverse of its price-to-earnings ratio - comfortably exceeds the ten-year gilt yield, Russ Mould notes in The Telegraph. On that measure, shares still offer better value.
Yes, markets can fall sharply. Even so, equities can grow your capital and may offer some protection against inflation - an especially relevant benefit under current conditions.
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