Smart investors are exploiting bond market chaos – so can you

Here’s how to cash in on guilts and get guaranteed returns while reducing the risk. By Paul Lewis

After years in decline, savings accounts are popular again, with returns of over 5pc on instant access accounts and more than 6pc on one-year fixed accounts.

But there is an alternative – with no risk to your capital and which does not affect the £85,000 Financial Services Compensation Scheme limit.

Government bonds, or “gilts”, can give a post-tax return to higher-rate taxpayers of 4.5pc to 5pc. To get the same in a taxable savings, your money would have to be earning about 8pc. Even a basic-rate taxpayer would need to be earning interest of more than 6pc if their savings interest was taxed.

Gilts have a reputation for being complex and risky and something only professional investors do. But with guaranteed returns like this on offer, many ordinary investors are finding out how to buy them and in ways that take away any risk at all.

One stockbroker reported this month that gilts were the most popular investments for its customers and the average amount invested was more than £ 129,000. Another reported that gilt sales were up 828pc compared with a year ago.

The Government issues a gilt when it needs to borrow money. A gilt always has a face value of £100, a fixed interest rate (called a coupon) paid in two half-yearly instalments, and a maturity date on which the Treasury will give the investor their £100 back.

The Government has never defaulted on its debt obligations, so you are virtually guaranteed to get your money back.

Private investors can’t buy gilts when they are issued. You must buy them on the secondary market usually through an investment platform, such as Hargreaves Lansdown or AJ Bell, and the gilts are always available at less than the £100 value of the bond.

For example, a gilt known as TN25 pays 0.25pc interest and matures on Jan

That completely overwhelms the 34p of taxable interest earned over that period leaving a higher-rate taxpayer with a yield of 4.63pc after tax. That is equivalent to earning 7.72pc in a taxable cash deposit account.

You can use Telegraph Money’s online gilts calculator to see how much you could earn. The yield calculation is a complex one that takes account of the present value of money and may not agree with other calculators you might find on the internet.

The bond has to be held until the maturity date to get these guaranteed returns. If money is urgently needed the bond can be sold, but there is no guarantee what return, if any, will be made. That will depend on the market price at the time and could even be a loss.

At present bonds are relatively cheap. That is because the fixed interest they pay is generally low. A bond paying 0.25p on its £100 face value is inevitably going to sell for a lot less than £100. But the return on that gilt is well over 4.5pc when the tax-free capital gain is taken into account.

That is why bonds which reach their maturity date soon have a real return for taxpayers which is better than cash. Long- term bonds by contrast return mainly interest which is taxable. To take advantage of the tax-free capital gains pick short- dated gilts that mature in months or a year or two at most.

You can find a list of gilts and their current market price via stockbrokers. When you have picked the gilt you want to invest in, enter its details in the Telegraph Money gilts calculator. You need to know the price paid per £100 bond, the date of purchase, the maturity date, and its fixed interest rate or coupon, and finally your income tax rate. The calculator will give you the tax-free yield of the bond at your tax rate.

The calculator also takes account of the cost of buying bonds through a broker. One of the cheapest offering overthe- phone dealing is AJ Bell with a £9.95 fixed fee for any deal and half that for frequent investors.

Hargreaves Lansdown charges 1pc with a minimum of £20 rising to £50 on deals above £5,000.

Interactive Investor charges £3.99 a deal, but there is an £11.99 monthly fee simply to have an account (those with less than £50,000 pay a lower fee). In addition, there will sometimes be what are called “custody charges” for keeping your portfolio of gilts. Check charges carefully.

With gilts held to their maturity date your capital is not at risk and your returns are guaranteed. They are best for investors with at least £50,000 to invest and who can tie up their money to fixed dates in the future.