What Are Gilts and Bonds? A Plain-English Guide for UK Investors

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"Bonds" is one of those words that gets used constantly in personal finance without much explanation. Model portfolios recommend a percentage in bonds. Robo-advisers rebalance into bonds as you get older. News headlines talk about "the bond market" moving, as if everyone already knows what that means.

A bond is simpler than the jargon suggests: it's a loan. You lend money to a government or a company, and in exchange they promise to pay you interest on a fixed schedule and return your money at an agreed date. That's the whole idea. Everything else, gilts, yields, duration, index-linking, is detail on top of that basic mechanism.

This post covers what a bond actually is, what makes UK government bonds ("gilts") different from other bonds, how bond prices and yields relate to each other, and a tax quirk specific to gilts that surprises a lot of people who assume all fixed income is taxed the same way.

What a Bond Actually Is

Say a government wants to borrow £1,000 for ten years. It issues a bond with:

• A face value (or "nominal" or "par" value) of £100, the amount you get back at the end.
• A coupon, the interest rate paid on that £100, usually twice a year. A "4% coupon" pays £4 a year on each £100 of face value.
• A maturity date, when the £100 is repaid in full.

You can buy that bond when it's first issued, or later from someone else who already owns it. Either way, you're lending money and collecting interest until the loan is repaid. This is fundamentally different from owning a share in a company: a bondholder has no ownership stake and no claim on profits, just a contractual right to interest payments and the return of capital.

That contractual, fixed nature is where the word "fixed income" comes from. Barring default, you know in advance exactly what you'll be paid and when.

Price and Yield: The Relationship That Confuses Everyone

Here's the part that trips people up. A bond's coupon is fixed at issuance, £4 a year on a £100, 4% bond, for its entire life. But the price you pay to buy that bond in the market moves constantly, and it moves in the opposite direction to interest rates.

Say interest rates in the wider economy rise after that 4% bond is issued, and new bonds now come with a 6% coupon. Nobody wants to pay £100 for your old bond when a new one pays more interest for the same money. So the price of your bond falls, say to £85, until the fixed £4 coupon on that lower price works out to a similar return as the new 6% bonds. That effective return, the coupon as a percentage of the price you'd actually pay today, is the yield.

The mechanical rule: when interest rates rise, existing bond prices fall. When interest rates fall, existing bond prices rise. This is precisely why bonds, often assumed to be the "safe" part of a portfolio, can lose value, sometimes sharply, when rates move against them. It's not a company going bust; it's simple arithmetic about what a fixed stream of future payments is worth today at a different interest rate.

Gilts: The UK's Government Bond

"Gilt" is simply the UK's name for its own government bonds, short for "gilt-edged security," a reference to the gilt-edged paper certificates once used to issue them. The UK Debt Management Office issues gilts on behalf of HM Treasury to fund government borrowing, and they're widely treated as one of the lowest-risk investments available to a UK saver, because the UK government borrows in its own currency and has never defaulted on gilt payments.

You'll see gilts named something like "4¼% Treasury Gilt 2032": the coupon (4.25%), and the maturity year (2032). Gilts are typically grouped by how long they have left to run:

• Short-dated: up to roughly 7 years to maturity.
• Medium-dated: roughly 7 to 15 years.
• Long-dated: 15 years or more, sometimes stretching past 2060.

The distinction matters because of duration, covered below: longer-dated gilts swing much more in price when interest rates move than short-dated ones do.

Conventional vs Index-Linked Gilts

Most gilts are conventional: a fixed coupon, a fixed maturity value, no adjustment for inflation. If inflation runs hot, the real value of both the coupon and the final repayment erodes.

Index-linked gilts work differently. Both the coupon and the value repaid at maturity are adjusted in line with inflation (specifically the Retail Prices Index, RPI, for UK index-linked gilts, with a lag of a few months). If prices rise 5% over a year, the value of the gilt broadly rises 5% too. This makes index-linked gilts attractive as a hedge against inflation, though they come with a trade-off: their prices are sensitive to real yields (interest rates minus expected inflation) rather than just nominal rates, which can make them volatile in their own right when real yields move sharply, as they did in 2022.

Gilts vs Corporate Bonds vs Bond Funds

Gilts are one type of bond. The wider bond market includes:

• Corporate bonds: loans to companies rather than the government. Because a company can go bust in a way the UK government essentially can't, corporate bonds carry credit risk, and pay a higher coupon than a gilt of similar maturity to compensate. That extra return over the equivalent gilt is called the credit spread, and it widens or narrows depending on how risky the market judges that borrower to be. Bonds are rated by agencies like Moody's, S&P, and Fitch, from AAA (safest) down through "investment grade" and into "high yield" or "junk" territory, where the risk of non-payment is materially higher.
• International government bonds: US Treasuries, German Bunds, and equivalents issued by other governments, each with their own currency, interest rate, and credit risk considerations.
• Bond funds and ETFs: rather than buying individual bonds, most retail investors access fixed income through a pooled fund holding hundreds or thousands of bonds, such as the iShares Core UK Gilts ETF or a global aggregate bond fund. This spreads credit and issuer risk across many holdings, though it also means the fund never "matures", it constantly rolls into new bonds as old ones mature, so it doesn't behave exactly like holding a single bond to a fixed date.

Duration: Why Long Bonds Move More

Duration is a measure of how sensitive a bond's price is to a change in interest rates. Roughly speaking, the longer a bond's maturity, the higher its duration, and the more its price moves for a given change in rates.

A short-dated gilt maturing next year barely reacts to a 1% rate change; you're getting your capital back soon regardless. A 30-year gilt, by contrast, has decades of future coupon payments whose value gets recalculated at the new rate, so its price can move dramatically. This is exactly what happened during the 2022 gilt crisis: as the Bank of England raised rates sharply, long-dated gilts lost over 30% of their value in a matter of months, a scale of loss more associated with equities than with "safe" government debt. The 60/40 Portfolio and the Myth of Uncorrelated Returns goes into that episode, and the broader question of when bonds do and don't offset equity risk, in more depth.

The practical takeaway: "bonds" isn't a single risk profile. A short-dated gilt fund and a long-dated gilt fund can behave very differently in the same interest rate environment.

The Tax Quirk Almost Nobody Talks About

Here's a detail that's specific to UK gilts and genuinely useful to know.

Gains on individual gilts are exempt from Capital Gains Tax, and this exemption applies regardless of what account they're held in, even in an ordinary dealing account outside an ISA or SIPP. This is unusual: almost every other investment (shares, funds, property) is subject to CGT on gains held outside a tax wrapper. Gilts, along with a category called qualifying corporate bonds, are carved out.

Coupon income from a gilt, by contrast, is taxable as savings income if held outside an ISA or SIPP, subject to the Personal Savings Allowance and the starting rate for savings.

This asymmetry, tax-free capital gains but taxable income, has led some investors, particularly higher and additional-rate taxpayers with cash outside an ISA or SIPP, toward a specific approach: buying short-dated gilts with a low coupon that are trading below their £100 face value. Because the price is depressed relative to face value but rises steadily back toward £100 as maturity approaches (a process sometimes called "pull to par"), most of the return comes as a capital gain rather than as taxable coupon income. Since that gain is CGT-exempt, the effective after-tax return can compare favourably with a taxable savings account paying a similar headline rate, particularly once someone has used up their Personal Savings Allowance.

This isn't a recommendation to buy gilts over cash savings; the right comparison depends on an individual's tax position, how long the money can be tied up, and the actual after-fee yield available at the time. But the CGT treatment is worth knowing about, since it's rarely mentioned in general "what's a bond" explainers and it's specific to the UK.

Not to Be Confused With: Premium Bonds

A common source of confusion: NS&I Premium Bonds are not bonds in the sense described in this post. They pay no interest at all. Instead, your capital is entered into a monthly prize draw, and returns come from occasionally winning a prize (or not). They're a savings product with a lottery mechanic wearing the word "bond." Premium Bonds: Are They Worth It? covers how the odds and expected returns actually work.

Savings bonds offered by banks (fixed-rate savers, sometimes also called "bonds") are different again: a fixed-term savings account with a set interest rate, not a tradeable security, and no secondary market or price fluctuation. They share the fixed-term, fixed-rate structure with a gilt, but none of the market pricing mechanics.

Where Bonds Fit in a Portfolio

The traditional pitch for bonds in a portfolio is stability: less volatile than equities, providing income, and historically rising in price when equities fall (a flight to safety, met with rate cuts). That relationship held reliably from the late 1990s through 2021, but it isn't a fixed law, as 2022 demonstrated when equities and bonds fell together. Bonds still play a role: reducing overall portfolio volatility, providing a predictable income stream, and offering somewhere for capital to sit with materially less uncertainty than equities over shorter horizons. But the assumption that bonds automatically cushion an equity downturn deserves more scrutiny than it typically gets, particularly in an environment where inflation, rather than growth, is the dominant economic concern.

The amount of bond exposure that makes sense, and the split between short and long duration, gilts and credit, depends heavily on time horizon. Someone decades from retirement has little need for the stability bonds provide and more time to ride out equity volatility. Someone drawing an income now has a much stronger case for holding bonds to dampen the sequence of returns they experience.

How Scenarios Helps

Understanding what a gilt or a bond fund actually is only gets you partway. The harder question is how much of a portfolio should sit in bonds versus equities, how that balance should shift as retirement approaches, and how a given allocation actually performs across a wide range of possible interest rate and inflation environments, not just the last twenty years.

In Scenarios, you can build a portfolio across asset classes, including equities, bonds, cash, and property, and run it through 1,000 simulated market paths to see the range of outcomes it produces. You can compare a bond-heavy allocation against an equity-heavy one, test what happens if a 2022-style rate shock hits early in retirement, or see how an inflation-linked bond allocation changes the picture versus conventional gilts.

You can model your own portfolio for free and see how different bond allocations affect the range of outcomes in your own plan.