If you are like me and my clients, you do like a little bit of cash.  Since 2009 it has earned you precious little and when you consider most of us will pay tax on the interest, the ability of any cash holding to create a meaningful return has been awful.

But shouldn’t I invest my cash?

I can’t buy food or pay tax with either bricks, loans, or shares!  Cash is integral in my everyday life, and I stick to the principal of carrying enough cash for my spending purposes and a little bit extra for emergencies.  Happily, emergencies don’t come around all that often but the need to keep the bills paid is ever present.

My golden cash rules?

I tend to hold cash for any expense that is coming up in 3 years.

If my expense is likely to come up between 3 – 5 years, I like to place a cautious investment with the view of beating cash returns over that period.

Over 5 years, and my investment is made into my growth portfolio.

I believe that if I give my investments enough time, they will return positively and over my career they genuinely have.  Therefore, if I control my cash flow, I will never come to call on my investments. Meaning selling them at a loss is avoided.

UK Treasurys make a come back (Gilts)

Ben (our investment director) and I have been anti-UK Gilts for almost 15 years!  Too much downside risk for too little return.  To recap a Gilt Edged Stock (Gilt) is a loan you make to the UK Treasury.  Their interest rate, in theory, tracks the expected Bank of England Base Rate over different time maturities.

I posted an updated-on LinkedIn in September last year saying how the 5-year Gilt, plus 1%, is a good yardstick for a 5-year fixed mortgage rate.  It is still true.

A 3-year Gilt, less 1%, is also roughly the return NS&I fixed term bonds provide.

Most, mortgages, and NS&I products simply buy Gilts as a way of lending or taking in deposits and the 1% margin then impose is their fee.  A super simple and effective business model.

But why UK Gilts now?

These offer the ultimate security for a fixed term deposit, and since 2008, I have not been tempted to chase a fixed term deposit rate by placing a bank deposit into banks I’ve never heard of. While they may have a UK banking license and therefore, I could deposit £85,000 and have FSCS protection, it just doesn’t feel right to me.

Gilts are now yielding over 2 years slightly above 5% (pursuant to current prices etc) so to me they are a secure way of depositing money, and the gross return is nice.

Gilts have a uniqueness though, which the tax planner in me loves.

UK Gilts are tax efficient.

Any capital gain made on a gilt is tax free.

Any income provided by a gilt is subject to income tax.

On a 2-year gilt, the 5% return is made up of 0.625% interest and 4.375% capital.

As a 40% taxpayer this is significant for me

A 2-year gilt versus a 2-year bank deposit

If I’m willing to deposit for 2 years into a bank I have never heard of before, I can get 6% or I could buy a UK Gilt at 5%.  Which would you place?

Before you decide read this!

So, the power of tax efficient investments comes back again!  You also get your interest on the UK Gilt paid as you go, and most fixed term bank deposits pay interest at the end of the term so you can compound the small amount of coupon (interest) you get on the Gilt to boost your return too.  Plus, the Gilt can be sold at any time (pursuant to the current price), or you simply let it mature.

If you let it mature, you will have a guaranteed return from outset irrespective of any other market conditions (unless The Treasury doesn’t pay you back!)

Summary

I bought my 2-year gilt last week as I am looking to move house in either 1 year or 2 and so I cannot take any further risk on new funds I am saving between now and then.

A UK Gilt really fits my tax position meaning the net return is nicely my best option right now.

Please note this article is not a recommendation and you should always consult your financial adviser to ensure any investment is right within your financial plan.