While no investment is completely risk-free, gilts are considered low risk and offer a predictable level of returns, due to the UK government’s strong credit history. To date, the British government has never failed to make interest or principal payments on gilts. Though it’s important to remember that past performance is not a reliable indicator of future returns.
However, gilt market prices can still fluctuate, which may affect returns. Other risks to be aware of when buying gilts include:
Interest rate risk. When interest rates rise, gilt prices fall. This is because new gilts with higher yields become more attractive, reducing the market value of existing gilts. This particularly impacts long-term gilt holders, as longer-dated gilts are more sensitive to interest rate changes.
Inflation risk. Inflation can reduce the purchasing power of future dividends and the repayment of the face value of the gilt at maturity.
Credit risk: While, to date, the British government has never failed to make interest or principal payments on gilts, it is important to remember that past performance is not a reliable indicator of future returns.
Opportunity cost: The fixed returns on gilts may be lower than returns on other investments like equities or corporate bonds, especially during periods of economic growth. By holding gilts, investors might miss out on higher returns elsewhere.
Liquidity risk: If there’s low demand for a particular gilt in the market, the holder may be unable to sell it and will need to hold it until maturity.
Reinvestment risk: The risk of reinvesting proceeds from dividend payments or maturing gilts at lower interest rates.
While gilts are considered lower risk than many other investments, understanding these risks may help you decide if gilts align with your financial goals and risk tolerance.