Government bonds continue to be a safe investment in the UK, considering their less volatile nature. Compared to shares and stocks, UK government bonds offer better stability. So, if you are willing to invest in these bonds, how do you plan to get started? Read the article to know how to start it.
Including government bonds in your portfolio would be a great decision if you are not comfortable risking your investments. Both corporate groups and governments issue these bonds. However, not all of them are equal. Government bonds are less risky and offer a decent return.
What is a government bond and how does it work?
A bond is a type of loan that the government takes from investors. So, when you buy UK government bonds, you lend money to the government. In return, you enjoy the interest for lending out the money.
Since the interest rate is fixed, the term ‘fixed income securities’ is used to define bonds. When you make the investment, you already know the returns you would be getting. As a lender, you would get back the full amount when the bond matures on a pre-decided date.
It’s wise to buy a government bond in the UK with a decent interest rate and low risk. Sometimes, government bonds are also referred to as gilts. Using this money, the authorities finance public expenses.
Why should you buy UK government bonds?
Purchasing the right type of government bond would help you hedge against inflation. With rising inflation in the UK, you might be seeking an alternate investment avenue to counter the impact. An informed decision to purchase bonds should help you mitigate the effect of inflation in the long run.
Government bonds are backed by the trust of the UK government, which makes them a safe investment avenue. If you want to diversify your portfolio, purchasing government bonds would be a logical decision.
With UK government bonds, you can expect a steady income till the maturity period. Since these dividends are paid directly from the treasury of the UK government, bonds continue to be reliable investments.
Choosing the right type of government bonds
Investors should understand the different types of government bonds in the UK. The common types of gilts or government bonds in the UK include the following.
Conventional gilts
A conventional guild is the most common type of bond, where investors receive the interest biannually. On maturity, you would receive the final interest along with the entire capital. The tenure of conventional gilts is mentioned in the name of the bond itself. For instance, a three-year gilt implies it would mature in three years.
Index-linked gilts
The interest rate for index-linked gilts is variable, and you won’t receive a fixed income like conventional gilts. The retail price index (RPI) in the country largely determines this interest rate, also known as the coupon rate. For investors willing to purchase UK government bonds to hedge against inflation, index-linked gilts would be ideal.
Bond ETFs
In Bond ETFs, pooled investments are used to purchase a specific collection of government bonds. From this asset, the shares pay out dividends. However, beginners may not find the right choice in bond ETFs due to their complexity. The interest rates, dates, and maturity periods also vary.
3 ways to purchase UK government bonds
As a beginner, you can purchase UK government bonds in three ways. These include:
Buying the bonds through self-managed accounts
Just like you purchase shares, you can purchase government bonds through self-managed accounts. In this case, you need to manage your portfolio yourself and place your trades at the right time.
Purchasing bonds through a broker
As a beginner, it would be wise to purchase bonds through a broker. Just like stocks, bonds are sold in the market through brokers. Check out whether or not you can access your account through your bank. These financial institutes often purchase government bonds on behalf of their clients.
One of the prime advantages of purchasing UK government bonds through a broker is that the professionals would help you choose the best products. Accordingly, you can balance your risk-to-reward ratio.
Besides, brokers would take care of your paperwork and carry out the transaction on your behalf. For all these services, they would charge a commission.
Buying an ETF share owning a bond
You may also consider purchasing an ETF share that owns a bond through the stock market. However, there’s a slight difference. In this case, you won’t be purchasing an actual bond, but only a share of the fund.
This way, you can diversify your portfolio and mitigate risk exposure. Additionally, you continue to enjoy the dividends at fixed intervals.ETFs maximise the returns by investing in different bonds.
Conclusion
Before deciding to invest in UK government bonds, it’s wise to consider your financial stature. Accordingly, you can commit to locking in the funds for the specified period.
Also, check out the historical returns and risk profile of the bond you are willing to invest in. This way, you can draw your line of defence against inflation while strengthening your financial portfolio.
FAQs
What returns can I expect from UK government bond investments?
Historical records reveal that a 10 Years Government Bond fetched a return of 4.344% in the last decade. The highest return was 5.576% back in 2007.
What are the tax implications of investing in UK government bonds?
The interest you earn on government bonds in the UK is taxed at 20%. However, some government bonds are exempted from tax. If you decide to sell the bond before maturity, you need to pay tax on the capital gain as well as the interest. However, you can withdraw a maximum of 5% a year from government bonds without being subjected to tax.
How can I diversify my investment portfolio with UK government bonds?
A balanced investment portfolio should include both high and low-risk investments. Considering the low-risk profile of UK government bonds, you may consider investing in these products.
While stocks and shares tend to be aggressive, they also involve high risk. By including bonds in your investment portfolio, you can balance out this risk significantly.
