Many investors use their portfolio to generate a regular income to supplement or replace their earnings. UK government bonds – also known as gilts – are a popular choice for many, thanks to their ability to pay a regular income and tax efficiencies.
In 2024, Smart Investor saw a significant increase in customers buying UK government bonds.
At the end of January the most popular gilt on Smart Investor (TN25) matures leaving investors thinking about where to go next for another source of income.
What are Government Bonds
UK government bonds, also known as gilts, are IOUs issued by a national government. In exchange for effectively lending the government your money, you earn a regular fixed rate of interest, which is sometimes referred to as a coupon.
When the bond has reached the end of its set term, also known as when it ‘matures’, you get your money back (unless the government defaults).
When a bond matures, investors who hold that specific bond then have a decision to make on what to do with the proceeds – reinvest or use the money for something else. If you hold lower risk multi-asset funds or UK bond funds, it is likely that a core part of the fund’s portfolio will be held in gilts. The fund managers will deal with all the maturities and where to reinvest as part of managing the fund against its objective.
Read more on why you might invest in government bonds to meet your investment objectives.
How bonds have fared – and the road ahead
10-year gilt yields rose significantly (around 1%) throughout 2024, and have risen sharply again at the start of this year.
Luke Pearce, Senior Investment Strategist at Barclays UK Wealth Management, explains: “UK gilt yields have been volatile throughout 2024 thanks to a combination of events – economic data, the Bank of England (BoE), and the UK Autumn budget. Despite the BoE lowering interest rates throughout last year, gilt yields ultimately ended the year higher than where they started. This is particularly the case for longer maturity bonds.”
On the steep rise in yields so far this year, Luke Pearce added: “The trend in yields from last year has continued into this year. Some of this can be attributed to the global rise in bond yields, but markets also remained concerned over the UK’s fiscal situation – despite no real new news. This has caused longer-maturity bonds to suffer (at least in the short-term).
What’s also noteworthy is other UK assets have suffered in this latest rout over the first few weeks in January – Sterling is now trading at its lowest levels in a year, and UK domestic stocks have sold off aggressively.”
Given that interest rates have such a strong bearing on bonds, it’s key to keep a keen eye on what they might do in the future if you’re weighing up reinvesting in another gilt or bond.
Luke Pearce explains: “The market is currently expecting around two cuts of 0.25% by the BoE in 2025. In the longer term, rates are expected to settle at around 4.25%. In the very near-term, the markets perception of the UK’s fiscal situation will likely be the key driver of yields.
Of course, the path for interest rates will also depend on how the economic outlook evolves – in particular inflation. If the economy remains resilient and inflation progress remains slow, then what is priced seems reasonable.”
When rates fall bond prices typically rise and therefore the yield goes down which makes them less attractive. However, the exact opposite is true when interest rates rise as bond prices fall, yields rise, and bonds become more attractive for their regular income.
Why investors like gilts
There are several key reasons why investing in gilts is popular – a perception of safety and predictability, a regular income as well as diversification away from shares.
Lower risk
Unlike shares, gilts are largely seen as having low credit risk because of the unlikelihood that the UK government would default on its debts. According to the Debt Management Office (DMO), the UK government has never failed to make interest payments on gilts.
Income
If your investments are generating a higher return than you’d get from cash savings, it helps keep pace with inflation, reducing the chance of the spending power of your money being eroded over time.
Diversification of assets
Bonds provide an important counterbalance to shares and as a general rule of thumb, in the same market conditions bonds tend to move in the opposite directions to shares, and can deliver smoother, more predictable returns.
Tax-efficient
If held outside of an individual savings account (ISA), then the income from UK government bonds is liable for income tax, though any profit made from a gilt when you sell or when it matures it is free from capital gains tax
Bonds are not without risk of course. Bond holders also suffer during periods of inflation because the real value of the income – in other words, the income adjusted for inflation – diminishes.
Equally, the interest rate, or yield, available from gilts (or similar) is traditionally quite low given that it is seen as a lower risk investment. As is the case with investments across the board, you need to take on more risk to achieve potentially higher returns.
Income options for investors
Invest in bond funds
Investors can also choose to hold a portfolio of gilts by investing in a bond fund, rather than buying them individually.
A bond fund could be managed by someone who will choose the bonds to invest in, or you can invest via a tracker fund or an Exchange Traded Fund (ETF) which track an index of corporate and/or government bonds.
Corporate bonds are bonds issued by companies rather than governments. The latter can be relatively safe but are considered riskier than something like a gilt because companies are more prone to collapse than national governments.
The quality of the bond will depend on the issuing company – investment grade bonds are those from companies with good credit ratings, and therefore at low risk of defaulting on the loan repayments. Whereas, ‘high-yield’ bonds – sometimes referred to as ‘junk bonds’ – offer a higher rate of interest but come with more risk because the company issuing the bonds will have a lower credit rating and there’ll be a greater chance of it defaulting.
As with equity funds, bond funds differ – each will have its own strategy and objective and it is important to fully understand what a fund invests in and how this aligns with your investment goals before deciding whether to put money into it.
Directly buy bonds or gilts
If you’re looking to invest into specific bonds or gilts, you may be interested to see the 10 most popular gilts and bonds purchased by our customers in the last month.
For investors looking to follow a similar strategy of rolling over into another gilt maturing in January 2026, these are some options to consider.
Directly investing in bonds or gilts may not be suitable for all investors. Neither income nor capital is guaranteed. If you are unsure of the suitability of an investment for your circumstances please seek personal advice.
Ready-made Investments
Our Ready-made Investments (RMI) funds, managed and run by a team of investment professionals give you access to a mix of cash, bonds and shares – the proportion of these change as you move up or down the risk level of the funds. You can see the proportion of these funds invested in Bonds on our RMI page and in the fund factsheets. This allows you to benefit from our expertise, knowledge, and research. There are five RMI funds, with each rated according to their risk level making it simple to choose the one that’s right for you.
Alternatives for income seekers
As well as bonds, there are other ways to use your portfolio to generate a regular stream of income.
Equity income funds and trusts
Some investment trusts and funds target producing an income from shares. The manager will look to invest in established, cash generative companies which have potential to pay out significant dividends to shareholders.
Investment trusts that aim to deliver income have a unique feature that allows the manager to hold back up to 15% of that income so if there’s a bad year or two for companies sharing profits, there’s still money to pay out. Alternatively managers can choose to pay out all the income as it’s received.
If you’re interested in UK equity income funds, there are several on the Barclays Funds List.
Dividend income from shares
Income generated from shares is in the form of dividends – a share of the annual profits that a company hands out.
Many businesses have provided significant dividends in the past, and that have a track record of growing profits, which means those dividend payments grow over time. There are no guarantees when it comes to dividends, however. They can be cut or stopped at any time.
Our Research Centre provides a wealth of data and tools for analysis when it comes to choosing individual shares.
If you're interested in what other people have been buying, we publish our most popular shares (updated weekly), using the number of purchase and sales deals placed by our Smart Investor customers during the previous week.
Remember that one of the most tax-efficient ways for income-seekers to invest is through an individual savings account (ISA) as there is no tax to pay on income from dividends or from bond interest.
You have an ISA allowance of £20,000 each tax year, and your money is also sheltered from income and capital gains tax.
