In this debt-based investment, you loan money as a creditor to a government in return for an agreed rate of interest on the amount at regular intervals.
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Government bonds, also referred to as government securities or G-Sec, are debt instruments issued by the Central or State governments to raise money through investors for meeting their capital expenditures. In this debt-based investment, you loan money as a creditor to a government in return for an agreed rate of interest on the amount at regular intervals.
The funds raised with government bonds are used for expenditure on new projects like infrastructure, roads, schools, etc. Before understanding how the government bonds work, let’s take a look at how many types of government bonds there are and what makes them different from each other. In India, short-term bonds are called treasury bills with a maturity of less than one year. Treasury bills or T-bills are available with different maturity periods ranging from 91 days, 182 days to 365 days. On the other hand, bonds with a maturity of more than a year ranging from five to forty years are long-term securities called government bonds.
While the central government issues both T-bills and government bonds, the state governments only issue bonds called State Development Loans (SDLs). These government bonds or T-bills can be purchased during an auction. The auction dates, bond sales, and securities to be sold are announced beforehand.
Should one invest in govt bonds?
It was only after 2001 that retail investors could participate in government bond auctions through a non-competitive bidding limit of 5% of the total amount that the government sought for the bonds. Bidders at the auction mostly consist of institutional investors such as banks, primary dealers, financial institutions, mutual funds and insurance companies.
Among the retail investors are individuals, companies, corporate bodies, and any other institutions permitted by the Reserve Bank of India with a current account or a Subsidiary General Ledger (SGL). But should an individual invest in them? Well, why not? They are a good option for portfolio diversification and help in reducing the risk or exposure to one particular asset. For the investor, government bonds make a well-diversified portfolio as it mitigates the risk of the overall portfolio. Further, investing in certain bonds can help save tax on the investment. For instance, the tax-free bonds of the National Highway Authority of India (NHAI) or Rural Electrification Corporation Limited (RECL) are not only safe to invest in but these bonds are also exempted from wealth tax, and no TDS is deducted from the interest on these bonds.
Another way investors can save capital gains tax is by investing in sovereign gold bonds. These are also government securities but they are denominated in grams of gold. They are not only a substitute for holding physical gold which saves on capital gains tax and making charges, but also give the investor the ongoing market price of gold at the time of redemption/premature redemption. But one should only invest in bonds when they don’t have the risk-taking capacity. In such a situation, it helps maintain a regular income. Especially those nearing retirement age should go for safe investment options like government bonds. Meanwhile, the young investors in their 30s can invest 30% in bonds and the rest in stocks due to their higher capacity to take risks.
When can you invest in bonds?
It is often advisable to invest in bonds when stock markets are volatile as it reduces the risk. However, another way to determine the right time to invest in bonds is on the basis of fall and rise of yield. The price of the bond rises when bond yield falls, hence if you are expecting a decrease in interest rate, then you can buy the bonds for capital gain. You can also invest in tax-saving bonds if you are aiming to save tax on capital gains but you will have to do that within the time frame of the particular tax section.
To conclude, let’s take a look at some of the basic features of government bonds and what makes them a suitable investment for a retail investor:
Features of G-Sec
● No default risk: The fact that the bonds are issued by the government makes them highly secure and low-risk investments.They are backed by the Indian government’s credit, which means that a coupon payment is guaranteed along with the return of principal investment after the maturity period is over. Another high-level security provided to the investment is through bonds being held in Demat accounts.
● Bidding through the electronic platform: Retail investors can directly bid for bond auctions through Reserve Bank of India’s e-Kuber platform. The RBI has allowed retail investors to open gilt accounts. They have been provided with online access to the government securities market (primary and secondary) through the RBI (Retail Direct).
● Mutual Fund Route: The most common route for retail investors to buy government bonds is through government securities (gilt) mutual funds. The mutual fund further invests in government bonds. Other ways to invest include registering on stock exchanges for non- competitive bids.
● Bonds as Collateral for Taking Loans: Another benefit of binds is they can be used as a collateral loan against short-term borrowings in the repo market. You can exchange the securities for cash along with an agreement to repurchase the bonds in the future specified date at the end of the contract.
(The writer is the founder of Finology)