Explain Gilts/Bonds to me like I am 5 years old please?

GenX0212

I will freely admit to knowing very little about this subject but have seen it mentioned numerous times on this board.

My understanding is you buy a bond at a set price, the bond pays an annual coupon (%) and the money is repaid at the end of the term at a normal face value of £100 per bond.

As an example looking at Hargreaves Lansdowne I can see the following 2 examples:

https://www.hl.co.uk/shares/shares-search-results/t/treasury-4.125-29012027
Buy £99.89, Coupon 4.125%, Maturity 29/01/27

https://www.hl.co.uk/shares/shares-search-results/t/treasury-1.25-22072027-gilt

Buy £93.74, Coupon 1.25%, Maturity 22/07/27

Which of the two is the better option, is there one? 

How do we assess which is the better value?

Can someone please explain to me in simpleton terms. Many thanks.

Marcon

GenX0212 said:

I will freely admit to knowing very little about this subject but have seen it mentioned numerous times on this board.

My understanding is you buy a bond at a set price, the bond pays an annual coupon (%) and the money is repaid at the end of the term at a normal face value of £100 per bond.

As an example looking at Hargreaves Lansdowne I can see the following 2 examples:

https://www.hl.co.uk/shares/shares-search-results/t/treasury-4.125-29012027
Buy £99.89, Coupon 4.125%, Maturity 29/01/27

https://www.hl.co.uk/shares/shares-search-results/t/treasury-1.25-22072027-gilt

Buy £93.74, Coupon 1.25%, Maturity 22/07/27

Which of the two is the better option, is there one? 

How do we assess which is the better value?

Can someone please explain to me in simpleton terms. Many thanks.

Try this: https://commonslibrary.parliament.uk/what-are-gilts-a-simple-guide/

QrizB

If you plan to hold the gilt inside an ISA or pension, and hold it until it matures, it's the Gross Redemption Yield (GRY) figure that's the most useful comparison.

I haven't checked but I would expect the GRY for those two gilts to be quite similar.

zagfles

GenX0212 said:

I will freely admit to knowing very little about this subject but have seen it mentioned numerous times on this board.

My understanding is you buy a bond at a set price, the bond pays an annual coupon (%) and the money is repaid at the end of the term at a normal face value of £100 per bond.

As an example looking at Hargreaves Lansdowne I can see the following 2 examples:

https://www.hl.co.uk/shares/shares-search-results/t/treasury-4.125-29012027
Buy £99.89, Coupon 4.125%, Maturity 29/01/27

https://www.hl.co.uk/shares/shares-search-results/t/treasury-1.25-22072027-gilt

Buy £93.74, Coupon 1.25%, Maturity 22/07/27

Which of the two is the better option, is there one? 

How do we assess which is the better value?

Can someone please explain to me in simpleton terms. Many thanks.

The first one gives you higher interest but virtually no capital gain. The second one gives you low interest but a capital gain. Which one is better depends if you hold unwrapped or in a pension/ISA, and your tax status. No capital gains tax on gilts, but the interest is taxable unwrapped.

So generally low coupon gilts are better unwrapped and high coupon better in a pension/ISA, but you'd have to do the sums based on your circumstances and whether you need an income from them, or what you'd do with the income if you don't need it. 

af1963

"which is better" depends on the needs of the buyer. If one was unambiguously better then the other, then everyone would buy that one and nobody would buy the other.

Both will return a similar total between now and their maturity dates in 2027 (final value, plus coupon payments) but the first one costs about £100 to buy and will return £100 at the end, so the return is virtually all made up of coupon (interest) payments at 4.125%.  The second one is cheaper to buy so it will deliver (£100 - £93.74)  = £6.26 as a capital gain, plus smaller coupon payments of 1.25%.  For some people, it may be better for tax purposes to choose one or the other.

greatkingrat

Generally you can assume lots of clever people with computers are calculating the correct prices and none of them are going to be exceptionally good value, or exceptionally poor value. The main difference is with the higher coupon, you get more money now, while with the lower coupon you get a higher proportion of your return from the final payment.

Interest is paid six-monthly in January and July. So gilt 1 would pay 4 x £2.06 in Jul25/Jan26/Jul26/Jan27, plus £100 repaid in Jan27. Total received £108.24, cost £99.89. (8.4% return)

Gilt 2 would pay 5 x £0.62 in Jul25/Jan26/Jul26/Jan27/Jul27, plus £100 repaid in Jul27. Total received £103.10, cost £93.74. (10.0% return)

Although on those figures, gilt 2 looks better, it's not quite that simple because they have different end dates. With gilt 1 you could stick the £100 you get back in Jan27 into a savings account for six months and get another couple of quid by the time gilt 2 ends in Jul27.

kempiejon

GenX0212 said:

I will freely admit to knowing very little about this subject but have seen it mentioned numerous times on this board.

My understanding is you buy a bond at a set price, the bond pays an annual coupon (%) and the money is repaid at the end of the term at a normal face value of £100 per bond.

As an example looking at Hargreaves Lansdowne I can see the following 2 examples:

https://www.hl.co.uk/shares/shares-search-results/t/treasury-4.125-29012027
Buy £99.89, Coupon 4.125%, Maturity 29/01/27

https://www.hl.co.uk/shares/shares-search-results/t/treasury-1.25-22072027-gilt

Buy £93.74, Coupon 1.25%, Maturity 22/07/27

Which of the two is the better option, is there one? 

How do we assess which is the better value?

Can someone please explain to me in simpleton terms. Many thanks.

There are a couple of good reasons for me holding gilts. First in my SIPP as a way of giving me a known amount of money at set dates years into in the future, using index linked for furthest into the future and as a tax efficient method of parking cash (for a known amount at maturity) in unsheltered accounts using low coupon short dated conventional gilts.
So as for which one is best for me would be whether I needed a sum in January 2027 or July 2027. Or if I wanted income from natural yield the 4.125% would have larger annual income in a sheltered account but a higher tax liability in unsheltered accounts. 

zagfles

greatkingrat said:

Generally you can assume lots of clever people with computers are calculating the correct prices and none of them are going to be exceptionally good value, or exceptionally poor value. The main difference is with the higher coupon, you get more money now, while with the lower coupon you get a higher proportion of your return from the final payment.

Interest is paid six-monthly in January and July. So gilt 1 would pay 4 x £2.06 in Jul25/Jan26/Jul26/Jan27, plus £100 repaid in Jan27. Total received £108.24, cost £99.89. (8.4% return)

Gilt 2 would pay 5 x £0.62 in Jul25/Jan26/Jul26/Jan27/Jul27, plus £100 repaid in Jul27. Total received £103.10, cost £93.74. (10.0% return)

Although on those figures, gilt 2 looks better, it's not quite that simple because they have different end dates. With gilt 1 you could stick the £100 you get back in Jan27 into a savings account for six months and get another couple of quid by the time gilt 2 ends in Jul27.

The interest will be a bit less because you'll pay accrued interest when you buy, if you buy now you'll pay 2 months interest which goes to the seller and then get 6 months interest in July. You could also account for interest on the coupons if you invest them elsewhere, so making a bit more on the higher coupons one. 

ISTM that the market accounts for the different tax treatment, so you generally make a bit more gross overall with higher coupon gilts but will pay more tax if held unwrapped, so which is better usually depends whether you hold unwrapped or in a pension/ISA. 

Newbie_John

1) Buy £99.89, Coupon 4.125%, Maturity 29/01/27

2) Buy £93.74, Coupon 1.25%, Maturity 22/07/27

In 2027 each of them will be wroth £100.
First one - you pay £99.89 and in 2027 you will get a £100. 
Second one - you pay £93.74 and in 2027 you will get a £100.

This income will be classified as capital gains which on gilts is tax free. 

They also have coupons 4.125% and 1.25% which can be seen as yearly interests - on which you would need to pay tax if you go over £1000/£500/£0 interests limits tax dependent.

Which one is better? All in all they very similar returning around 4.0% (in a different way for tax purposes).

If I earn £20k a year, have no other savings, want to invest £20k - then first one is better.
If I earn £150k a year, run out of ISAs etc, want to invest £20k - then the second one is better.

GenX0212

Thanks everyone, really helpful comments.

The circumstances I am considering are as follows:

Haves:

• Currently 56
• Retirement at age 57 holding ~ £600k in workplace DC pension;  ~ £100k in SIPPs;  £13k a year in DB benefits.
• My wife also currently 56 can take a small pension early but to keep things simple I will discount that from the conversation
• Both are entitled to maximum SP and cannot improve what we already hold any further.

Wants:

• Aiming for ~ £48k a year income up to State Pension age (67) and if markets perform then hopefully still having a decent chunk of pension left. 
• As my wife is the same age then at SP age we would have 2* State Pensions + £13k DB = £35k a year as a minimum guarantee. If it comes to it then we are OK with the fact that we might have less at SP age because by then we think it likely we will be spending less. 
• Also accept the total will be less if/when either of us dies but with death benefits and SP would still have a minimum of about £20k a year which again would be OK as a single person.

What I am considering is seeking to guarantee some element of the £700k pot for the period from 57 to SP so that in the event of a market collapse then we would still have the £13k DB plus further guaranteed income paying out across those years.
I'm thinking about the possibility of using maybe £200k to build a Gilt ladder - in rough terms that would provide £20k a year giving a total guaranteed income of £33k with a remaining pot of £500k to drawdown against and top up our annual income. 

If I have my figures right then we would need £15k + £7k tax from drawdown = £22k so would be a withdrawal rate of about 4.5%

Would really welcome people's thoughts and confirmation that my figures are in the right ballpark?

DRS1

Most of your pension is in a DC workplace pension.  Are you planning to leave it there or move it to a SIPP?

If leave it there, does it allow the sort of drawdown you want?

And assuming you build your gilt ladder inside the DC workplace pension does it allow you to hold individual gilts?