Synopsis–Soon retail investors will be able to buy government bonds directly from RBI. Though there are certain advantages of investing in government bonds, experts warn against rushing in to buy bonds for various reasons.
The common investor’s dream of buying government bonds directly will become reality once RBI makes its retail direct platform operational. Lower costs will be the main draw of direct investing. At present, investors have to go through either mutual funds or insurance companies and the asset management fees eat into the net returns. Avoiding concentration risk is another advantage of investing in government bonds. “It makes sense to have some investments in government bonds because investing everything in banks or mutual funds will lead to concentration risk,” says Piyush Khatri, Sebi registered investment adviser (RIA).
However, experts warn against rushing in to buy the bonds for various reasons. First, the rates on short-duration papers right now are very low, much lower than the fixed deposit rates offered by banks like SBI. For instance, SBI offers 5.5% interest on 1-year FDs for senior citizens (5% for others), compared to just 3.8% one would earn from government bonds. Senior citizens have additional access to options like Senior Citizens’ Savings Scheme (SCSS), PM Vaya Vandana Yojana (PMVVY), etc which offer much higher returns. Everyone can invest in RBI floating rate bonds now and the rate (7.15%) is much better than the 5.55% yield on 7-year government paper. The floating interest is also a good thing. “Floating rate bonds are good now because there is limited room for RBI to reduce rates further and rates are expected to move up in the next 1-2 years,” says Melvin Joseph, Managing Partner, Finvin Financial Planners.However, government bonds can be a good substitute for annuity plans from insurance companies. As of now, investment options that go beyond 15 years are limited and that is why people rely on immediate annuity provided by insurance companies. Since we are going to get back the money from government bonds, one needs to compare rates of immediate annuity for life with return of premium. Immediate annuity provided by LIC Jeevan Akshay for a 60-year-old is just Rs 53,950 for an investment of Rs 10 lakh—just 5.40% compared to 30-year government bond yield of 6.7%. The reason for this big difference is insurance companies provide immediate annuity after locking in the receipts in long dated government papers and the difference can be considered as the expense ratio. Investors can save this difference if they buy these government bonds directly.
Another advantage of buying government bonds directly would be liquidity. Investors will be able to sell these bonds in the secondary market. However, as this will be a new platform, investors will need to make sure that there is enough liquidity before getting in. Illiquidity is a problem faced by investors on several corporate bonds listed on the BSE and NSE now. Settling for proxies like Bharat Bonds ETFs can be one way to avoid illiquidity. You can invest in Bharat Bonds ETFs 2023, 2025, 2030 or 2031 depending on your holding period. Since Nippon India Nivesh Lakshya Fund invests in government papers that mature in 2044, 2045 and 2046, it is a good substitute if your investment horizon is 25 years. While the expense ratio of Bharat Bonds ETFs is close to zero, expense ratio of Lakshya is 0.52% for regular plans and 0.20%for direct plans.
Investors should also consider the taxation angles. While the entire interest from these bonds will be taxable, indexation benefit on long term capital gains from debt mutual funds help to reduce tax incidence. “Due to better liquidity and also lower tax incidence, investors who want to lock-in for 25 years should consider products like Nippon India Nivesh Lakshya,” says Gajendra Kothari, MD & CEO, Etica Wealth Advisors.
Investment is also about the convenience of operations, especially for senior citizens. As of now, government bond interests are paid either half yearly or annually and that may not suit elders who need regular monthly income. One can circumvent this by staggering investments. Some senior citizens may also want to consume more than the interest if they are not interested in leaving a legacy for their heirs. “Systematic withdrawal plans (SWP) can be adjusted according to requirements and therefore, will be more convenient than selling bonds in secondary market,” says Kothari.
Note that the upcoming platform suits only knowledgeable investors. As debt means fixed returns for most investors, they may not be able to stomach the mark to market losses in these bonds. “Only investors who understand rate sensitivity should get in. Bond prices will fall if yields go up in future and investors should not blame RBI for that,” says S. Sridharan, RIA.
(Graphic by Sadhana Saxena/ET Prime)