Should you buy Government Securities directly?
They are issued by the Reserve Bank of India and come with both short and long maturity and you can choose what tenure suits you. The benefit comes from being Government-backed hence, practically no default risk.
Have you ever thought of investing in Government bonds as a regular part of your long-term investment portfolio? Not just the ones that help you save tax, but regular bonds of different maturities issued by the Government? Maybe you aren’t sure what they are and how you can buy them.
In bond market parlance, these are called G Secs. They are issued by the Reserve Bank of India and come with both short and long maturity and you can choose what tenure suits you.
The benefit comes from being Government-backed hence, practically no default risk. Long tenure G Secs are issued for 10-30 years. There are short maturity bonds as well-known as treasury bills which come with a tenure of 14 days to a year.
Until now, you could buy these bonds and treasury bills through specified bond-buying facilities offered by stock exchanges, brokers, and a few banks. The process is like an auction, where you apply for the issue with a bid price. Only large institutions had access to direct buying of such bonds from RBI. Last week, it was announced that individual investors like you and me could access Government bonds directly by opening an account with the RBI.
This is good news since you get direct access to an optimum return, a low-risk asset to add to your portfolio, at the same time there are nuances that you need to train your mind to understand better.
Fixed return, but flexible too
Just like in a fixed deposit, for a G Sec too the return and investment time period is defined. However, unlike fixed deposits, G secs are also listed and traded on stock exchanges. What this means is that G secs can be bought and sold every day through the market mechanism. Many large institutions transact in government bonds of different maturities on a daily basis. This also leads to price fluctuation. Here is where it gets complicated for individual investors.
If interest rates are trending lower, bond prices in the market rise as existing bonds are paying a higher coupon and demand increases. When interest rates are rising in an economy, prices of existing bonds fall because one hopes to get a better return from new bonds with higher expected interest coupons.
At the time of buying, you pay the face value of the bond and expect to get the annual interest each year. Ideally, you will hold the bond till its maturity and get back your principal along with any interest that is still due.
But what happens if you need to redeem your bonds earlier than maturity? You can sell in the secondary market or through stock exchanges. However, it’s not as simple as getting the face value in return for each bond when you make this secondary market sale.
In the secondary market, bond prices move up and down just like the price of a share. It depends on demand and supplies on the one hand, plus, the interest rate expectation and trend in the economy plays a part.
If interest rates are trending lower, bond prices in the market rise as existing bonds are paying a higher coupon and demand increases. When interest rates are rising in an economy, prices of existing bonds fall because one hopes to get a better return from new bonds with higher expected interest coupons.
At any given point between the time you buy and maturity, the secondary market price of the bond is unlikely to be the same as its face value. Secondly, the volume of trade on the day you want to sell may not be supportive of absorbing small individual lots.
Thus, selling before maturity or before the bond is bought back by the RBI, may not get you the value you expect from it; it could be higher or lower, depending on the interest rate trend and traded volume. If you don’t want this flexibility or volatility in your return, simply hold the bond till it matures.
What you should do?
The interest received on these bonds will be taxable, however, for the long-term bond (three years plus holding period) this is a lot more tax-efficient than investing in fixed deposits. In the short term, deposits and G secs have a similar tax structure, hence you can choose based more on the return and flexibility you are looking for.
Just like you buy fixed deposits and hold till the bank returns your money, you can consider these for your long-term debt allocation. Ideally, invest only that portion of your savings which you won’t need to break into before the bond tenure is over. These bonds are not ideal for short-term funds kept aside for emergency use.