How the gilt ladder is calculated

The full method behind the calculator, step by step.

1. The payment schedule

You choose the first and the last year of payments.
There is one payment in each year in between, all of the same size.
Flat ladder: the same number of pounds. Inflation-uplifted ladder: the same amount of today’s money.
How large that payment can be is what the calculator works out.

2. The gilts and their prices

It uses every conventional and index-linked gilt in issue at the pricing date.
Each is priced off UK nominal and real gilt yield curves, built from market data on –.
The price includes interest built up since the last coupon (the “dirty” price).
These are model prices, not broker quotes. A real purchase would differ slightly, plus dealing costs.

3. Finding the cheapest set of gilts

The method is cash-flow matching, the same one our app uses.
Of all the sets of gilts that pay for every year, it picks the one that costs least today.
A set qualifies if, by each payment year, everything paid out so far covers everything owed so far.
Money that arrives before it is needed is kept and spent later.
One rule keeps it a ladder: a gilt only pays for the years from its own maturity up to the next year another gilt matures.
Technically this is a linear programme. It has a single best answer, which the calculator finds exactly.
When the income starts some years away, coupons received in the meantime go towards the first payments.
That is why low-coupon gilts tend to be chosen for a later start.
For index-linked gilts the same steps run in today’s money, using each gilt’s uprating to date (its indexation ratio).

4. Money held between payments

Gilts do not mature in every year, especially beyond the 2050s.
Coupons do not arrive exactly when payments are due.
Whatever arrives early is held until it is needed.
It is assumed to earn a short-term interest rate equal to inflation, so it keeps its value in today’s money.
Flat ladder: the market-implied (breakeven) inflation rate is used. Inflation-uplifted ladder: the cash simply holds its value.
Short-term rates have often been above inflation, but not always.
The most cash held, and any years with no maturing gilt, are listed under “The gilts in this ladder”.

More detail: why some years are paid from cash

Why a rule is needed.

Gilts are priced at market yields; cash held is assumed to earn only inflation.
A low-coupon (“deep-discount”) gilt can yield more than the gilts maturing after it, around the peak of the yield curve.
On those numbers, the cheapest plan could be one gilt whose repayment is held in cash for many years.
The income would then depend on cash, not gilts – what a ladder is meant to avoid.

The ladder rule.

A gilt’s repayment may only pay for the years from its own maturity up to the next year another gilt matures.
A year with a gilt of its own is never paid by buying more of an earlier gilt and holding the cash.

Why some years are still paid from cash.

If the income starts later, coupons arrive in the meantime. That money is kept and spent.
It goes first to years whose only gilt has a high coupon: paying that year from cash in hand costs less.
A year in which no gilt matures is paid from money received earlier too.

5. Scaling to your amount

Matching is linear: twice the income needs twice of every gilt.
The calculator matches a reference schedule, then scales it to cost exactly your amount.
The payment that falls out is the income shown.

6. Pounds and today’s money

Flat payments are known in pounds; inflation-uplifted payments are known in today’s money.
To show both on one basis, the calculator uses the market-implied (breakeven) RPI inflation curve of the same date.
It grows inflation-uplifted payments at that rate to estimate them in pounds.
It shrinks flat payments at that rate to estimate them in today’s money.
Those figures are estimates. The curve is the market’s price of inflation, not a forecast.
The curve starts at three years, so the first two years use the three-year rate.

Gilts are issued by the UK government, which has never defaulted on a gilt, though that is not a guarantee of future performance. The market price can go up or down, but unless the UK Government defaults the gilt will deliver the promised cashflow at maturity. The market price of an index-linked gilt can go up or down, but unless the UK Government defaults it will deliver the promised inflation-linked cashflow at maturity.

Back to the gilt ladder calculator

Capital at risk. The value of investments can fall as well as rise and you may get back less than you invest. Past performance is not a reliable guide to future returns. The figures shown are illustrative examples based on model assumptions and market data; they are provided for general information only and do not constitute financial, investment, tax or legal advice, a personal recommendation, or a financial promotion. The gilts listed are an illustration of cash-flow matching and are not a recommendation to buy, sell or hold, nor an endorsement of, or a reflection on the merits of, any gilt shown; you are under no obligation to act on it. Allocatewise is not authorised or regulated by the Financial Conduct Authority. Figures are shown before tax and do not reflect your personal tax position. If you are unsure whether an investment is right for you, seek advice from a regulated financial adviser. See our full disclaimer.