Savers should look to gilts for better returns

Banks have been slow to pass on the Bank of England’s (BoE) interest rate hikes to consumers, although with the top savings accounts on the market now offering rates of 4.15% or 5.76% if you’re prepared to fix for a year, that’s starting to change. 

Still, for ISA savers and higher-rate taxpayers in particular, the options remain limited. Most investment accounts pay less than 2% interest on cash balances, while the top cash ISAs offer rates below 4%. 

A better option could be UK government gilts and money market funds. The Financial Times reports there’s been a surge in buying of UK gilts as investors have rushed to take advantage of the higher yields on offer. 

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Winterflood Securities, which acts as a government-appointed dealer for UK debt, noted a seven-fold jump in demand for gilts from retail investors last month compared to the same period last year. 

Hargreaves Lansdown, the UK’s largest online stockbroker, has reported a 15-fold rise over 12 months. Meanwhile, interactive investor, the UK’s second largest investment platform for private investors, has seen an 879% increase year-on-year in fixed-income trading (95% of which is gilt trading). 

Savings accounts vs gilts 

It’s easy to see why. Savers can buy a one-year gilt with a 5.3% yield, with a chunk of this return coming from tax-free capital gains – particularly useful for higher and additional rate taxpayers. 

For example, through Hargreaves Lansdown you can buy the Treasury 1% gilt issue, maturing 22 April 2024. At a mid-market price of £96.60, this bond has a yield to maturity of 5.20%.

Yield to maturity measures the total return of the bond until maturity, including capital growth and income. Gilts are redeemed at par value, £100 so in this case, an investor could book a £3.40 capital gain on each £100 of the bond acquired, as well as any income paid between now and April next year. 

You should take close note of exactly when the coupon interest is paid – you can see those payment dates on the Debt Management Office website. This will determine the exact income return you can expect to receive. 

If you shop around, you can find gilts matching both your upcoming cash requirements and tax profile. Additional rate taxpayers might want to look at the 0.25% gilt maturing on 31 January 2025. Trading at £92.3, the bond has a yield to maturity of 5.25%, mostly from capital growth. 

Risks to be aware of 

That said, with all gilts, there are some risks to be aware of. Interest rates could go higher and thus the market price of the bonds could fall as bond prices move inversely to interest rates. If you are happy to hold through to maturity, there’s no real risk at all as you’ll get exactly what you were promised on the maturity date.

And like all securities, these gilts are traded on an exchange with a bid-offer spread and the accompanying market liquidity risks, but these are likely to be almost non-existent as they are liquid UK government securities. 

Sam Benstead, Deputy Collectives Editor, interactive investor, explains, “Investing in fixed income directly requires careful research, and an alternative would be money market funds, which offer the income of gilts, but without the complexity, while also mitigating the risk of bond price fluctuation – but it’s still important to do your homework."