Is investing in government securities an attractive proposition?
Authored by Tejas Khoday, co-founder and CEO of FYERS
'Don't put all your eggs in one basket.'
This catchphrase is of immense importance in the world of investing. From investing in equity, mutual funds, fixed deposits, and gold to real estate, diversifying a portfolio can safeguard against inflation and pitfalls of the stock market.
The majority of risk-averse investors in India love risk-free, safe, and secure investment options. So, if you are one of them, Government securities or G-secs can be a great addition to the portfolio.
On behalf of the Government of India, the RBI (Reserve Bank of India) issues G-secs such as bonds to fix the fiscal deficit. Erstwhile, investment in G-secs got restricted to banks, financial institutions, and corporates. With the Retail Direct Gilt Scheme launch in 2021, investment in G-secs got streamlined for retail investors.
Backed by sovereign guarantee and zero default risk, G-secs are capable of garnering faith in the investing community.
Retail investors are new to the world of investing in government securities. So, learning the nuances of investing in government securities is essential.
What are Government Securities?
Government securities are financial instruments issued by the government to fund the fiscal deficit. Government Bonds, Treasury bills, and SDL are government securities. Investors invest funds in government securities in return for a fixed return on investment. The securities are issued for the short-term as well as the long-term. Short-term security with tenures of less than a year is called treasury bills (T-bills), and long-term securities with a tenure of more than a year are called Government bonds.
Why are Government Securities issued?
Government securities are debt financial instruments issued by the government to raise capital from the general public. Government issues securities such as Government bonds and utilizes the funds raised to build special infrastructure, fund daily projects, expand operations, and meet other budget requirements. Apart from using funds raised through taxes and borrowings from banks, funds raised through government securities get utilized for completing big infrastructural projects like metro, national highways, and railways.
Also, funds borrowed in the form of loans from banks and other financial institutions carry high-interest rates. So, the amount raised through government securities is comparatively cheaper than any other source of revenue generation.
What are the varied types of Government Securities?
Government securities are the safest and risk-free, offering excellent opportunities to diversify the portfolio's risk.
Sneak-peek into the table showing different types of Government Securities.
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Types of Securities
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Features
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Treasury Bills
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- A financial instrument with a maturity period of less than a year.
- Issued in three maturity periods, i.e., 91, 182, and 364 days.
- They are zero-coupon securities, as there is no interest payable.
- Issued at a discounted rate and redeemed at its face value.
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Central Government Bonds
(G-secs)
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- Long-term maturity of more than a year.
- Interest is credited on a half-yearly basis.
- The rate of interest can be fixed or floating.
- Investments can be made at par, premium, or a discount.
- They are money-market instruments with a broad range of tenures, starting from 5 years and extending upto 40 years.
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State Development Loans
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- Long-dated Maturities.
- Interest is credited semi-annually.
- Investments can be made at par, premium, or discount.
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What are the pros of investing in Government Securities?
Take note of some of the key advantages of investing in government securities.
Backed by a sovereign guarantee from the Government of India, investment in these securities is almost close to a nil default risk. So, the coupon payment and principal repayment are guaranteed and risk-free.
This sense of security is uncommon and closely resembles the feeling of investing in fixed deposits.
Government securities are liquid in nature. You can easily trade them in the secondary market and pledge for loans. Banks can also use the bonds issued to meet the Statutory Liquidity Requirements.
- Portfolio Diversification
Low-risk financial instruments with guaranteed returns lay a solid foundation for a portfolio. While designing a portfolio, having a perfect combination of risk-free and risky assets reduces the overall risk exposure.
You can invest in government securities and build a well-diversified portfolio.
What are the cons of investing in Government Securities?
Take note of some disadvantages of investing in government securities.
Ideally, an investment will pay a return in reference to the risk taken. The additional return over and above the normal compensates for the risk taken. However, that is not the case for government securities, as they are characterized to be risk-free. Due to this, government securities offer lower returns vis-à-vis other forms of investment.
Although government securities do not suffer from any credit risk/default risk, they are subject to interest rate risk. In the rising interest rate scenario, the old government bonds' prices will fall because of the increasing investor participation in new bonds with higher coupon rates. It is important to note that the investors entering the transaction from the issue date will not suffer losses for the bonds held till maturity.
What are the applicable taxes on government securities?
The interest credited to the bank account is considered 'Income from other sources and taxable at the applicable tax slab rates. Investments held for over a year are long-term capital gains taxable at 10 per cent, and those less than a year are short-term capital gains taxed at the applicable slab rates. Interestingly, there is no Tax Deducted at source (TDS) for the interest received on the government securities.
In the case of T-bills, returns (Par value-Discount value) are considered short-term capital gain and taxed at the applicable slab rates.
How to invest in government securities?
The onset of digitisation has redefined the world of investing. You can now invest in government securities in the following ways.
Similar to buying securities through a stockbroker's platform, you can also buy government securities. As and when government security is issued, the platform gets updated. You can purchase these securities through a bidding process or an auction.
You can also invest in government securities directly through NSE goBID mobile app/web platform or RBI Retail Direct websites. Complete the KYC compliance and registration process and invest in your preferred securities.
You can also invest in government bonds through mutual funds. Now there is no need to decide on the bond explicitly. The mutual fund manager will pick the bond catering to your investment requirements.
Key Takeaways
In a nutshell, government securities are conservative financial instruments with consistent returns and negligible risk. Investment in government securities is a haven for risk-averse investors while you are building a well-diversified portfolio and aiming to minimize risk exposure. However, keeping an eye on the rise and fall of interest rates and other factors is crucial before you dabble in debt financial instruments.
Disclaimer: The opinions expressed above are personal and may not reflect the views of DSIJ.