Government bonds are back in focus as the 10-year gilt yield sits near 5pc, above the levels seen during the bond market crisis of October 2022.
For many cautious savers, equities remain uncomfortable. Shares can fall in a downturn, sometimes sharply, and that risk may not suit people who need more certainty over a fixed period. But cash is not risk-free either. Money held in a bank account, building society account or cash Isa can lose value after inflation, even when interest is reinvested.
Over the past decade, savers would have lost around £18 of real spending power for every £100 held in cash, even after reinvesting interest.
Index-linked gilts offer a different route. These are UK Government bonds where both the interest payments and the repayment at maturity are linked to the Retail Prices Index. The coupon is usually very low, but the amount repaid by the Government rises with inflation over the life of the bond.
Retail Prices Index has typically run about one percentage point above the Consumer Price Index, which is now the more commonly used inflation measure. As a result, an index-linked gilt held to maturity can do more than match CPI inflation. It can beat it.
The key phrase is held to maturity. If an investor buys an index-linked gilt and keeps it until its maturity date, the repayment is made by HM Treasury and is adjusted for inflation. That gives the investor a clear real return profile. The UK Government has not defaulted on its bonds for more than 300 years, and it has a strong incentive to preserve confidence in the gilt market because it needs to keep borrowing.
Investors can also sell gilts before maturity. The market is liquid, so selling is usually straightforward. However, an early sale means accepting the market price available at the time. That price will be affected by real interest rates, so the inflation-beating outcome is no longer guaranteed if the bond is sold early.
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