UK government bonds or ‘gilts’ are getting a lot of attention from investors right now. This is illustrated by the fact that on Hargreaves Lansdown, gilts have been among the top 20 most purchased securities for the last three weeks.
Should I buy some of these bonds for my own portfolio? Let’s discuss.
High yields on offer
I can certainly see some appeal in owning gilts right now. For starters, potential returns are relatively high at present.
Take the Treasury 0.25% 31/01/2025 (TN25) security that featured among Hargreaves Lansdown’s most purchased securities last week.
It currently has a price of around £92.80. This means that if I were to buy it now, and hold it until maturity (31 January 2025), I’d receive a return of about 7.8% (£100 divided by £92.80 = 1.078) plus the 0.25% annual interest.
Overall, the yield to maturity – the total annual rate of return between now and the gilt’s maturity date – would be about 5.2% (ignoring any trading commissions or platform fees).
Secondly, risk levels are low (assuming the gilts are held until maturity) because these securities are backed by the UK government.
And bonds also have a negative correlation to stocks, meaning they don’t move in sync. This means that by owning some gilts alongside my stocks, I could potentially reduce the overall risk of my portfolio.
Stocks generate higher returns
Gilts have their flaws though. One thing that concerns me is yields are still below inflation.
If I was to pick up a 5.2% yield from the security I mentioned above, I may still end up going backwards in real terms if inflation stays at current levels (8%).
This is where stocks have an edge over gilts. Over the long run, stocks tend to provide returns of around 7-10% a year. So they’re generally a better inflation hedge than bonds.
I think with a diversified portfolio of high-quality stocks that includes companies such as Apple, Microsoft, Alphabet (Google), and Visa, there’s a good chance I will earn a higher return than 5.2% a year between now and 31 January 2025.
But I may not, of course. The stock market is unpredictable in nature and can be volatile at times.
Another issue for me is that interest on gilts is often fixed. So the income from them remains static over time. This isn’t ideal when inflation is running high.
This is where dividend growth stocks such as Diageo and Unilever have an edge, as these stocks offer a growing income stream. Diageo, for example, has increased its dividend payout by around 75% over the last decade – well above inflation. Dividends are never guaranteed though.
Should I buy gilts?
Considering my financial goals (building long-term wealth over the next 20 years), I probably won’t be buying gilts for my portfolio any time soon.
To my mind, locking my money away for a fixed period at a rate below inflation isn’t really worth it.
I’d prefer to keep cash I need in the short term in high-interest savings accounts and invest my long-term capital in high-quality growth stocks.
