Everyone is talking about investing in bonds… but should YOU? Expert reveals what you could earn & pitfalls to avoid

GOVERNMENT borrowing costs are at a 28-year high, spelling bad news for the Chancellor John Healey. But for savers looking for tax-efficient ways to build a nest egg it’s a great opportunity. Sun Money takes a look at whether you can make some cash from the market crisis. The 28-year high in government borrowing costs is bad news for new Chancellor John Healey Credit: Reuters But one person’s trash is another’s treasure – and you can make extra cash from the market crisis Credit: Getty Gilts – the name given to government bonds – aren’t usually exciting investments, as they rarely deliver the blockbuster returns on offer from some shares. However, if you’re looking to build a portfolio of investments that gives you regular payments then they could be for you. Here’s what you need to know… What are UK government bonds? The Bank of England pays close attention to the price of UK government bonds Credit: PA Government bonds are essentially IOUs. You lend money to the government for a fixed time period that it uses to fund its spending, such as paying for healthcare, schools and new roads. In return you get regular interest payments over that period and then your money back on the date the bond ends – known as the “maturity date”. These fixed periods can be for as little as three months to as much as 50 years. UK government bonds are also considered low risk because it’s unlikely that the government would not be able to repay you. The drop in gilt prices could be a great buying opportunity for new investors Credit: Getty What everyone is talking about is the returns from this kind of bond, which have shot up. The returns on a bond are called a “bond yield” which is the interest it pays out to the holder, expressed as a percentage of its price right now. For example, a UK government bond maturing in December 2038 has interest payments of 4.75% and costs £92.96. This means when you buy £92.96 worth you will get £100 back on maturity (gaining £7.04) and £46.51 as interest payments after tax – assuming you’re a basic rate taxpayer. To match this return, a basic rate taxpayer would need a savings account paying 4.71%. The reason yields are so high is that prices have dropped like a stone, and because the interest is fixed, when the price drops the yield automatically rises – good news for investors. Sarah Coles, head of personal finance at investment platform AJ Bell, said: “The price of UK government bonds has dropped significantly, so anyone selling out of a gilt fund at the moment would face the risk that it will have dropped in value. However for new investors this could be a great buying opportunity. “If you buy into a bond fund, you’ll get the regular income, but there’s also a chance you’ll eventually also see bond prices rise. “That means you’ll make money that way too, as if the bonds you own in the bond fund become worth more money on the open market, meaning, the total value of your investment goes up.” How to invest in bonds Want to get involved? There are a couple of ways to get a slice of the action Credit: Getty If you want to use government bonds to boost your savings there are two ways you can invest. The first is an investment through a bond fund that holds UK government bonds. The second way is to buy an individual bond and hang onto it until it reaches its end date. Buy a bond fund A fund spreads your money across lots of different investments, in this case a variety of bonds – including government bonds. Your money is pooled with that of other investors and a fund manager then buys and manages a wide mix of individual bonds, so you do not have to choose them one by one. Unlike an individual bond, a fund does not mature; it constantly buys and sells bonds, so you could be in line for a nice cash boost if bond prices rise, but you’ll be on the hook for losses if they fall. Bond funds do not, however, come with tax perks offered by gilts so it makes sense to invest using an Isa where you can invest tax-free. Buy individual bonds You can buy bonds direct from the Government’s debt issuer – the debt management office, although there are lots of hoops to jump through, so most people buy gilts on a secondary market – that is, bonds that other investors have sold before they ended. This is where you might pick up a bargain. That is, one being sold for less than the £100 you’ll get for it at the end. You can buy these from an investment platform such as AJ Bell and Hargreaves Lansdown. Going down this route means there’s no risk associated with the price of bonds falling, because you’re never going to sell – you just wait for the debt to be repaid. Plus, you’ll know exactly when you’ll reap the rewards from the investment, as individual bonds have a fixed date when you get your money. This helps if you have a plan for the money perhaps to pay for home improvements or a holiday. Gilts are issued in units of £100, known as the “par value”. If you can bag a bargain and pay less than £100, you will make a profit when the bond matures, as well as getting regular income. Buying bonds can be a good tax hack for higher rate taxpayers because any profit made from a UK government bond is free from capital gains tax, unlike many other investments such as shares, funds or investment trusts held outside an Isa. The risks of buying bonds As always with investing, there are risks of actually losing cash Credit: Getty However if you buy into the bond market, there are risks to your money. Buying individual government bonds still involves the very small risk that the UK government fails to repay its debts. Interest rate uncertainty is also a common cause of bonds losing value as prices go down when interest rates rise. Sarah said: “The falling price of bonds are the result of continued tensions in the Middle East. It raises concerns that oil prices could stay higher for longer, which would mean higher inflation. “This in turn would mean the Bank of England would need to raise interest rates to keep inflation under control. When this happens, gilts look less attractive by comparison.” How much you could earn Bond funds are not known for their mega returns but can offer a steady stream of interest payments – making them a reliable investment. However, in recent decades the performance of gilt funds has been particularly disappointing. In fact, if you’d paid £25 a month into iShares Core UK Gilts UCITS ETF – an investment fund that allows investors to track the performance of gilts and gain exposure to them – for 10 years with dividends reinvested, you’d have £2,717 – after paying in £3,000. This means you would have lost money on your investment. If you’d started paying in during 2006 when the fund was launched, you’d have £6,240, so you’d be slightly ahead. However, past performance isn’t necessarily a guide to what you could make in future. If you opt for an individual gilt, the return you’re likely to get is clearer. For example, you buy an individual UK government bond that was originally issued during the pandemic and it’s set to mature soon, they tend to be priced below their initial value. Right now, there’s one due to mature in January 2028 with an interest rate of just 0.125%, priced at £94.66. While that interest rate is low, there’s money to be made on the price you get on the end date. So with this bond we’re talking about, you’ll get £100 for every £94.66 you put in on the maturity date in January 2028. You’ll also receive a small monthly payment. So should you invest in government bonds? Should you invest? It could be worth a look, especially if you think inflation may be lower in the future Credit: Getty Experts agree that UK government bonds aren’t for everyone. But Jason Hollands of wealth manager Evelyn Partners highlights that they are relatively predictable if held until their end date. He warns: “But you could still make a loss if you sell the bond before the maturity date and prices have fallen. “Remember, this is an investment and bonds should not be treated as a substitute for an instant-access savings account.” Coles added: “If you have money to invest today then UK bonds are worth looking at – especially if you think inflation might be lower in future.” This is because bond payouts often follow interest rates, so if rates fall the payout you are likely to get from future government bonds will be less valuable. So now is a good time to lock in. “You might think a bond fund that holds gilts has some potential to take advantage of rising prices or prefer to buy an individual bond and hold it to the end date. It’s a personal choice,” Coles said. Hollands pointed out that investing in UK bonds could be helpful after next April when there’s a planned reduction in the cash Isa limit to £12,000 for those under age 65. “You might consider using some of your stocks and shares Isa allowance for money you would otherwise have held in cash,” he added.