Lootman wrote:daveh wrote: If any one can see any grave errors I've made in my thoughts let me know.
No grave error that I can see. But given how many Lemons seem to be piling into these kinds of positions it is certainly prudent to ask what the catch might be:
1) This is not an investment, in the sense that you will not secure any growth. At best you are maintaining the real value of a sum of cash. So it is a cash management strategy rather than an investment strategy. And so you should not allocate more of your net worth than you otherwise would to savings accounts and the like.
2) Anything you devote to gilts is a sterling exposure. So if the pound does terribly in the next few years, this is still a losing strategy relative to alternatives.
3) For most of the last 40 years gilts have traded above par. So you would have had a loss if held to maturity and moreover one that you could not offset against taxable gains. This opportunity may prove to be short-lived and then the opportunity goes away. If you believe that then you would probably want to extend maturities in the hope of selling above par if rates decline. Some of the issues currently trading below par were at 130-150 not so long ago, dispelling the myth that gilts are somehow always "safe".
1. There is growth
2. Maybe/maybe not. Better or worse is generally a 50:50 chance, the markets tend to price things to that chance. Unlike savings accounts that have £85K protection limits, you can lend unlimited amounts to the treasury (buy Gilts) with nigh on 100% full protection, £1M, £10M ... whatever. The Treasury are more inclined to increase general taxation or get the BoE to print money rather than default on their Gilts.
3. Present index linked gilts real yields are generally positive of recent. Provided the Gilt is held to maturity that real gain is guaranteed, even if inflation rose to 25% or more.
I'd add that low coupon yield Gilts are near tax exempt. You'll pay some tax on the small amount of interest that a 0.125% yielder pays, but the inflation and price appreciation elements are tax free. If you can earn inflation + 1% and inflation runs at 5%, you're making 6% near-as tax-free. For another who had their cash in a savings account that incurred 20% taxation on interest, they'd need to be receiving a 7.5% gross interest amount to compare. And they'd only get back £85,000 if the bank went bust.
Index Linked Gilts are similar to conventional Gilts, you just have to put a 'real' hat on
https://www.yieldgimp.com/index-linked-gilt-yieldsT28 was first sold on 11th June 2018
https://www.londonstockexchange.com/sto ... mpany-page coupon value 100, and set to be redeemed (mature) on the 10th August 2028 at a 100 value ... in real terms. The interest rate offered being 0.125% relative to its 100 face value. Investors bought that gilt when issued, perhaps paying more or maybe less than the 100 value, and have received the interest paid since, as has the 100 nominal value been uplifted by inflation.
For you to buy from a existing holder/seller at the above indicated rates, the indicated real price is 95.11, a near 5% below its 100 maturity price value. So you're guaranteed a near 5% gain as indicated. But that's in real terms, you'll also get whatever inflation is between when you buy and when it matures. The Market price value of 95.11 is however misleading as that's not the price you'll pay, you'll pay a actual price of 100 scaled by however much inflation there's been since the gilt was first issued to the present date. How many Gilts will you get? Easiest is just to ask for £12,345 or whatever value/amount when you buy, and they'll do the calculation for you.
The Break Even value indicates that if inflation between now and maturity were 3.82% or higher then having bought the Index Linked Gilt was better than having opted for Conventional Gilts. If inflation was lower than that value then you'd have been better having bought a conventional Gilt. A factor to consider there however is that inflation is unlikely to turn to deflation, as the government will pull out all of the stops to avoid that. In contrast inflation could rise to extreme levels, 25% or more perhaps.
There's some additional factors involved, such as the actual inflation rate values used are lagged values, and you'll also have to pay the proportion of interest that the seller is due since they last received a interest payment (only fair).
At a coupon yield of 0.125% the actual interest payments are near insignificant. Predominately the (real) gain arises out of price appreciation. 95.11 indicated price rising to 100 (but with both scaled by inflation in actual terms, same difference either way) over 5 years approximately. Which annualised = 1.05^(1/5) - 1 = 0.98%. Adding on the 0.125% coupon yield increases that to 1.1% approximately. The above link however indicates the more accurate value to be a 1.04% real yield. Buy the Gilt at the above level, hold it to maturity and you're guaranteed a annualised return of 1% above inflation. Sell before maturity and you could gain more, or see a loss.
With a ladder, that's just replicated across many years, buying different Gilts that ideally each matured a year or so apart, but that in practice there aren't enough Gilt series to cover that so you just have to make do with what's actually available. If you're guaranteed a 1% real return for a Gilt, and want £10,000 of present day inflation adjusted money in 5 years time, then you can discount that by the 1% real rate. In the case of the TR28 1.0104^5=1.053, so instead of using £10,000 of present day money to buy £10,000 of inflation adjusted money in 5 years time, you only need to 'deposit' 10,000 / 1.053 = £9496.
Go deeper, further out, and for Index Linked Gilts maturing in 30 odd years time the indicated real yields are more around 1.4%. £10,000 of inflation adjusted money in 30 years time requires 1.014^30 = 1.52 factor, so you only need to invest 10,000 / 1.52 of present day money = £6579 of present day money for £10,000 of inflation adjusted money in 30 years time.
A full ladder for 10K/year for the next 30 years, 300K of total inflation adjusted returned money, might cost around £250K of present day money to buy. The actual calculations for a ladder are a bit more involved in that you should factor in both the interest you'll receive each year, as well as the proceeds from a Gilt that matures each year. But when the coupon yields are low such as 0.125% that's near insignificant. Low amounts of taxable interest, mostly price appreciation that is tax exempt is also the more tax efficient choice.
When you're getting a £300K return from £250K present day money, then you might invest that difference into a accumulation world stock index tracker or whatever. £50K dropped into a stock accumulation fund that was left for 30 years as the Gilt ladder was spent, might perhaps accumulate at a 6% real rate. 1.06^30 = 5.74 gain factor, such that £50K initial investment grows to £287K in inflation adjusted terms. You had 30 years of £10K/year inflation adjusted income provided from a £300K initial portfolio value and ended the 30 years with £13K less, £287K instead of £300K .... in whatever 30 year inflation adjusted terms. And unlike a annuity that is all-spent, lost to heirs when you die, the ladder and stock values remain available to heirs.
Risks to be mindful of is that things/rules can change, especially over a 30 year horizon period. If inflation did spike to 25% levels then there's quite a high probability IMO that a budget might change the tax exemption of inflation and capital gain exemptions. To some extent you are buying fire insurance from a arsonist. Yet to put a Gilt ladder into a ISA seems wasteful given its current tax exemptions.
which was only about indexation, not full on dirty prices. In real life your understanding is still correct.