UK Gilts (eg TR32) vs Bond Funds for Retirement Portfolio Balance (7-Year Horizon, Retiring at 57)

JamTomorrow

Hi all,I’m looking for insights on structuring the bond portion of my retirement portfolio, specifically whether to hold individual UK gilts like the 1% Treasury Gilt 2032 (TR32) to maturity or opt for bond funds with a similar duration. Here’s some context to help frame the discussion:

Background:

• Age and Retirement Plans: I’m 50 and plan to retire at 57 (in 2032). My pension holdings make up ~80% of our capital, so early retirement isn’t feasible.
• Financial Position: We have sufficient funds to support our desired lifestyle in retirement without needing to chase high returns. However, some additional returns above inflation and risk-free rates would enhance our comfort.
• Current Portfolio: I’m currently at a 20% bonds / 80% equities allocation, which I know is too equity-heavy for my risk tolerance and time horizon. I’m planning to shift to a more balanced allocation, or potentially even 100% direct bond holdings.

The Dilemma: I’m torn between two approaches for the bond portion of my portfolio:

1. Locking in Returns with Individual Gilts (e.g., TR32):
   • I’m considering holding gilts like TR32, which matures in 2032 (just before my retirement) and offers a yield-to-maturity of ~4.2% (as of recent data). This seems like a risk-free way to secure a predictable return, assuming the UK government meets its debt obligations (if it doesn’t, we’ve got bigger problems!).
   • This approach guarantees the 4.2% return if held to maturity, providing certainty and protection against equity market downturns. However, if equity markets soar, I might feel I missed out on potential gains.
2. Using Bond Funds (Average Duration ~7 Years):
   • Alternatively, I could allocate the bond portion to funds with an average duration of around 7 years, potentially mixing government and investment-grade corporate bonds for diversification.
   • I understand bond funds are meant to provide ballast and counter-correlate with equities, but I’m unsure if this counter-correlation holds as strongly with individual gilts held to maturity versus bond funds. In an equity downturn, would bond funds benefit more from a flight to safety (e.g., cash moving into bonds, boosting prices) compared to individual gilts, which lock in the yield but don’t capture price appreciation unless sold early?
   • But isn't the bond fund always hold around an average duration of 7 years so I would have to change my bond fund during the next 7 years

Key Concerns:

• Risk Tolerance: I’m ever more risk-averse as I approach retirement. A 30%+ equity market correction in the years leading up to 57 would be frustrating, potentially derailing our plans and stealing defeat from the jaws of victory.  Securing a stable return feels like the prudent choice, but I don’t want to be overly conservative and miss modest growth opportunities or the benfits of an AI led golden age (am I being greedy?).
• Counter-Correlation: Do individual gilts like TR32 provide the same portfolio diversification benefits (i.e., counter-correlation with equities) as bond funds? Or do bond funds offer better protection in an equity downturn due to their diversified holdings and potential price appreciation?

Questions for the Community:

1. Given  time horizon and risk profile, would you lean toward individual gilts like TR32 to lock in the 4.2% yield, or prefer bond funds for diversification and potential flexibility? Why?
2. How do individual gilts compare to bond funds in terms of counter-correlation with equities? Do funds provide better ballast in an equity downturn due to market dynamics (e.g., flight to safety)?
3. Am I overthinking the opportunity cost of locking in 4.2%? Given I don’t need to chase returns, is the certainty of individual gilts the clear winner for peace of mind?
4. Any other strategies or considerations I might be overlooking for balancing safety and modest growth over a 7-year horizon through to retirement?

[Written with the help of AI]

SVaz

I understand having 5-7 years income in a Gilt ladder,  I thought long and hard about doing the same from 2028-2032 , in the end I’ve opted for short term money market funds, which is a gamble on rates not falling below 3%.  I’m also only taking £10k a year x 6 so not massive amounts. 

But going 100% on bonds doesn’t seem sensible with 25 years+ to fund,  it’s traditionally 60/40 to allow growth to keep up with inflation,  but I am wary of bond funds as I was badly burned by the bonds fiasco in 2021. 

Linton

I would disagree with having a single portfolio with a predetermined equity/bond ratio based on what you feel seems right.

An alternative is to think in terms of liability matching. This could imply 3 separate independent tranches, one 100% equity for long term >10  years inflation matching and growth, a second for with a 5-10 year outlook, and a third close to cash to cover expenditure in the next 5 years or less.

The intermediate tranche could include a diversified range of income funds to generate cash for the 5year tranche, bonds (gilts or corporate) with a 5-10 year duration, and possibly specialist lower risk funds.

So your asset allocations are directly linked and justified by your income needs. Keeping higher risk equity for the long term should help ensure that you sleep at night as whatever the market does would not affect your income for 10 years.

Overall you should find that your equity/fixed interest ratio is around 60/40, though with a lower % 
In gilts than standard 60/40 portfolios.

Bostonerimus1

You are facing the usual issue with bond funds vs bond ladders and that's the interest risk inherent in bond funds. If you have the discipline to hold the individual bonds and sell at maturity that's the way I'd go. Or you could buy an annuity, but of course you give up your capital there.

SVaz

Or, a fixed term annuity with capital returned at the end.
When I looked,  it was an expensive way of doing things though, the rates were garbage,  probably due to me only being 60. 

Secret2ndAccount

You have described TR32 as a 1% Treasury Gilt which is incorrect, though you correctly note that it will pay about 4.2% if held to maturity. Maybe you are mixing it up with TG32.
TR32 pays about 4.2% per year then gives you your money back.
TG32 pays about 1.2% per year then gives you your money back, plus about 21%.
Personally I don't like bond funds. They can go down as well as up, just like equities. There is no guarantee that in seven years' time your fund will be worth more than it is today, and you don't have the choice to simply hold to maturity - that's the fund manager's choice. Don't assume that the fund manager is any smarter than a blind monkey. He is smart in that he gets his fee whether you profit or lose, but he is not smart when it comes to picking winning bonds.
A bond fund could be the right choice if what you want is constant buying and selling of bonds to maintain a particular goal. An individual might lack the knowledge or the time, and might have to pay a lot in costs for all that trading. You have a single, fixed target date in mind, so I don't see why you'd buy a fund. Your bonds will throw off income and you have to decide what to do with that - to reinvest it or buy something else. A bond fund would do that for you, so maybe there's one reason.

Your post makes no mention of inflation. Average inflation over the last 5 years runs close to 5%. If that were to repeat, your TR32 would leave you with less buying power than you have today. That is just as much a risk as holding equities which could be worth less, but could also return enough to beat inflation.
You can buy an index linked gilt T32 which pays about 1.1% per year, then gives you your money back plus inflation. Could turn out better or worse than TG32, but you are protected against high inflation.

Your stance seems a little too focused on equity risk to me. You cannot simply stand still because you are happy with your position. You don't have to try to sprint, but you at least need to walk at the same pace as everyone else in order not to be left behind.

JamTomorrow

SVaz said:

I understand having 5-7 years income in a Gilt ladder,  I thought long and hard about doing the same from 2028-2032 , in the end I’ve opted for short term money market funds, which is a gamble on rates not falling below 3%.  I’m also only taking £10k a year x 6 so not massive amounts. 

But going 100% on bonds doesn’t seem sensible with 25 years+ to fund,  it’s traditionally 60/40 to allow growth to keep up with inflation,  but I am wary of bond funds as I was badly burned by the bonds fiasco in 2021. 

Thanks.  Yes 100% on Bonds, especially individual bonds would not be a sound strategy for the next 30 years or so.  What I was looking to do was lock in a return up until retirement date to preserve existing capital when I may consider using some of the pension for an annuity.  But as I'm also concerned by inflation, as well as missing out on equity growth (whilst trying to dampen effect of an equity correction) I'm going to need some other asset classes in my portfolio.  I'lll also look more at money market funds.

JamTomorrow

Bostonerimus1 said:

You are facing the usual issue with bond funds vs bond ladders and that's the interest risk inherent in bond funds. If you have the discipline to hold the individual bonds and sell at maturity that's the way I'd go. Or you could buy an annuity, but of course you give up your capital there.

Yes I have the discipline and would consider using some of the pension at 57 to lock in an annuiity that alongside 2 state pensions would give me and my Wife a solid income if we are lucky enough to make it to centenarians.

JamTomorrow

Secret2ndAccount said:

You have described TR32 as a 1% Treasury Gilt which is incorrect, though you correctly note that it will pay about 4.2% if held to maturity. Maybe you are mixing it up with TG32.
TR32 pays about 4.2% per year then gives you your money back.
TG32 pays about 1.2% per year then gives you your money back, plus about 21%.
Personally I don't like bond funds. They can go down as well as up, just like equities. There is no guarantee that in seven years' time your fund will be worth more than it is today, and you don't have the choice to simply hold to maturity - that's the fund manager's choice. Don't assume that the fund manager is any smarter than a blind monkey. He is smart in that he gets his fee whether you profit or lose, but he is not smart when it comes to picking winning bonds.
A bond fund could be the right choice if what you want is constant buying and selling of bonds to maintain a particular goal. An individual might lack the knowledge or the time, and might have to pay a lot in costs for all that trading. You have a single, fixed target date in mind, so I don't see why you'd buy a fund. Your bonds will throw off income and you have to decide what to do with that - to reinvest it or buy something else. A bond fund would do that for you, so maybe there's one reason.

Your post makes no mention of inflation. Average inflation over the last 5 years runs close to 5%. If that were to repeat, your TR32 would leave you with less buying power than you have today. That is just as much a risk as holding equities which could be worth less, but could also return enough to beat inflation.
You can buy an index linked gilt T32 which pays about 1.1% per year, then gives you your money back plus inflation. Could turn out better or worse than TG32, but you are protected against high inflation.

Your stance seems a little too focused on equity risk to me. You cannot simply stand still because you are happy with your position. You don't have to try to sprint, but you at least need to walk at the same pace as everyone else in order not to be left behind.

Thank you.  I think this helps me see that bond funds may not be the answer for me and you are right to call out inflation as this does concern me.  Basically I am happy for my capital to grow at say 4.2% for the next 7 years if inflation is below that, but that cannot be guaranteed.  I also want to mitigate against an equity correction but don't want to miss out on any equity upside.  

I think I am going to need a blend of equity and individual GILTs (maybe including IL ones to de-risk inflation).  See where this leaves us at 57 and then if annuities are good use some of the pension (from the bonds holding) to purchase a small annnuity of ~£15k/year and then decide how to reallocate remaining portfolio.  

Secret2ndAccount

You could go 1/3 equities, 1/3 TR32 and 1/3 T32. I'm not saying it's the best solution. Choosing the best solution requires:
1.  Deciding what you mean by best;
2.  Predicting the future

In the end, what you want is something that helps you sleep at night. For someone in your position I would suggest that annuities are a no brainer, but that's at today's prices. You can't buy them in advance, and who knows what they will offer in 7 yrs time.

OldScientist

A couple of comments - the horizon of 7 years takes you to retirement, but not beyond. With an individual bond held to maturity you run interest rate risk at maturity if it is to be reinvested.

In retirement, for many people income is the most important consideration (legacy may also be important). Guaranteed income (i.e., not dependent on market conditions) can come from SP, DB pensions, annuities, and collapsing gilt ladders.

The last of these can be built before retirement. For example, using the gilt ladder tool at https://lategenxer.streamlit.app/Gilt_Ladder it would appear that a 40 year ladder (i.e., taking you to 97) with a 7 year delay in starting that will provide an inflation adjusted £10k per year can currently be built for about £250k. While this is complex to construct, it is relatively easy to use in retirement (coupons and maturing bonds end up in your pension account).

An alternative, as already mentioned, is to purchase an annuity at retirement. Since, AFAIK, deferred annuities are not currently available in the UK, in order to lock in the current good rates, inflation linked gilt funds or individual gilts that match the duration of the annuity (roughly half the life expectancy at purchase) plus the delay until purchase will ensure the income at purchase is roughly the same as now (yields and payout rates going down will lead to price rises in the gilts held and vice versa).