Gilts vs cash savings

sendu

Please pick holes in the following:

If YTM on UK Gilts of duration X is lower than the interest on instant access or fixed (for X years) savings accounts, there is no reason to buy the Gilts if you intend to hold to maturity. You're certainly better off using the savings account.

If you do not intend to hold to maturity, because eg. you might sell some each year as part of rebalancing your portfolio, then instant access/ 1 year fixed savings accounts are still the better bet, because the Gilts are unlikely to increase in value (eg. due to an interest rate drop) in 1 year to put you ahead of your savings. You can always re-asses each year to see if YTM on Gilts is now higher than savings, and potentially switch.

The same holds true for buying a UK Gilt fund with average duration of X, since it is likely comprised of Gilts with similarly poor yields to what you can get individually today.

What's the more nuanced way of looking at this topic that would help you to decide if and when to pick bonds (or bond funds) over cash savings? Ideally without having to make a bet on interest rates rising or falling in the future.

Prism

I hold enough cash to keep me under the personal allowance as I don't want to pay 40% tax on it. I don't really want to waste my ISA on cash so will probably look at a bond fund next - likely a hedged global government ETF.

sendu

Prism wrote: »

I hold enough cash to keep me under the personal allowance as I don't want to pay 40% tax on it. I don't really want to waste my ISA on cash so will probably look at a bond fund next - likely a hedged global government ETF.

Do you expect that ETF to outperform cash savings then? Is this because you see global bonds have better yields?

If similar to UK gilts, isn't it more wasteful to have bonds in your ISA than cash?

to_jackie_too

sendu wrote: »

Please pick holes in the following:

If YTM on UK Gilts of duration X is lower than the interest on instant access or fixed (for X years) savings accounts, there is no reason to buy the Gilts if you intend to hold to maturity. You're certainly better off using the savings account.

This is correct if you are comparing to a fixed-rate savings account, and that has a higher rate than the YTM of a gilt with the same duration. I don't think fixed rate savings accounts are available for longer than about 5 (or perhaps 7?), years, so you may not be able to compare to gilts of longer duration. You can't directly compare a 30-year gilt to a series of six 5-year fixed-rate accounts, because you only know what the latter will pay for the first 5 years.

Instant-access savings is not a relevant comparison, except for very short-term gilts (e.g. 1 year), where it's near enough.

If you do not intend to hold to maturity, because eg. you might sell some each year as part of rebalancing your portfolio, then instant access/ 1 year fixed savings accounts are still the better bet, because the Gilts are unlikely to increase in value (eg. due to an interest rate drop) in 1 year to put you ahead of your savings. You can always re-asses each year to see if YTM on Gilts is now higher than savings, and potentially switch.

This is about right for short-term gilts, but very wrong for long-term gilts. The latter can easily move 10% or more (up or down) in a year or less.

The same holds true for buying a UK Gilt fund with average duration of X, since it is likely comprised of Gilts with similarly poor yields to what you can get individually today.

Agreed that there is nothing fundamentally very different about a gilt fund, compared to individual gilts.

What's the more nuanced way of looking at this topic that would help you to decide if and when to pick bonds (or bond funds) over cash savings? Ideally without having to make a bet on interest rates rising or falling in the future.

As above: short-term gilts are easily beaten with savings accounts; e.g. you might keep part in instant-access accounts, and have a series of 1-year or 2-year fixed-rate accounts which mature at different times. Long-term gilts are not easily beaten because there is no direct equivalent in savings accounts: they do something different.

Now, I believe you can get a similar effect to holding a gilts fund which holds all maturities of gilts, from the shortest to the longest, by splitting your money between a short-term gilts fund and a long-term gilts fund (skipping the medium-term gilts). And the short-term gilts fund can be beaten by using savings accounts. So perhaps there is a case for splitting your gilts allocation between savings accounts and a long-term gilts fund (a few funds holding 15+ years gilts are available).

sendu

to_jackie_too wrote: »

This is about right for short-term gilts, but very wrong for long-term gilts. The latter can easily move 10% or more (up or down) in a year or less.
[...]
Long-term gilts are not easily beaten because there is no direct equivalent in savings accounts: they do something different.

Is there a way to assess the likelihood of long-term gilts out-performing cash? Or is it an essentially random chance of interest rates going up or down?

Or by "do something different", should they be thought of in a completely different way and judged by other criteria?

Prism

sendu wrote: »

Do you expect that ETF to outperform cash savings then? Is this because you see global bonds have better yields?

If similar to UK gilts, isn't it more wasteful to have bonds in your ISA than cash?

Undecided at the moment but probably not. Looks like the current yield is about 1.2% which is worse than a cash ISA at around 1.4%. However the ETF will likely go up during a downturn or interest rate decrease so I might hold a bit of both.

In the end I suppose premium bonds have a place too

to_jackie_too

sendu wrote: »

Is there a way to assess the likelihood of long-term gilts out-performing cash? Or is it an essentially random chance of interest rates going up or down?

You can try, just as you can try to estimate future returns from equities. But it probably might as well be random. With long-term gilts, it's not so much the current level of interest rates (bank base rate) that moves their price, as the market's changing expectations of where base rate will go over the remaining lifetime of the gilt. But then what determines those expectations? We only know what those expectations are supposed to be by looking at the prices of long-term gilts!

Or by "do something different", should they be thought of in a completely different way and judged by other criteria?

Yes, I wouldn't pick long-term gilts as an investment by themselves. (And, unlike cash savings, they're not suitable for money you'll be spending/using soon.) They may have a role to diversify a long-term portfolio which also contains a lot of equities. Because sometimes they do go up when everybody is panicking and equities are falling.

That said, when I've finished buying a house, I will just be holding a lot of equities and a smaller amount of cash. This is partly because the cash is dual-purpose: it can cushion me from falls in equities, but also be spent on things that may need doing to the house.

Linton

There is no comparison between gilts and savings accounts unless you hold the gilt to maturity. With bond funds you cannot do that as funds will hold bonds with a range of maturity dates (except for the possibility there could be some ETF somewhere with a fixed maturity date).


To see what I mean, lets look at a real gilt which pay interest twice yearly:



HL can sell you a gilt that matures on 7th December 2028 with an interest rate of 6% based on a value of £100, so £3/6 months. Great deal you may think. However £100 worth of this gilt will cost you £150 today. Is it really a good deal? You need a bit of maths to work it out. Plus you know that on the 6th December 2028 this bond will be worth £103 as the following day you will get the £100 initial value returned plus the final 6 months interest. In between now and the 6th December 2028 the price could move up and down significantly but it will be mostly down hill.


At the moment UK interest rates are low and there is not a lot of room for them to go lower. The effect is that in the medium term future it is quite possible that gilt prices will fall generally in addition to what would be expected as the gilt approaches maturity.

Brian65

The 10 yr Spanish Govt bond yield fell to zero yesterday.
It seems an odd way to manage money, to lend to the Spanish government for 10 years interest free.
No individual would do this with their own money, only highly paid people with degrees in Economics and Mathematics would do it with other people's money.
Something tells me we can't live in this Alice in Wonderland financial world much longer.

Will be a good case study one day.

Linton

Brian65 wrote: »

The 10 yr Spanish Govt bond yield fell to zero yesterday.
It seems an odd way to manage money, to lend to the Spanish government for 10 years interest free.
No individual would do this with their own money, only highly paid people with degrees in Economics and Mathematics would do it with other people's money.
Something tells me we can't live in this Alice in Wonderland financial world much longer.

Will be a good case study one day.

It isnt lending money to the Spanish Government interest free. When issued the bond would be at say 1% with a maturity of 20 years. So the Spanish Government pays 1%/year to the lucky bond owner.



Assume it was bought at 100 Euro. After 10 years its market resale value could possibly have risen to 110 Euros. So if someone bought it after 10 years they would get 10 euros interest from the Spanish Government and the original 100 Euros. net: zero.



If you had the odd 10M euro cash lying around and required instant access it might be cheaper to put it in a zero return bond than pay someone else to look after it.