Investors in general can be broadly classified into two categories, risk-takers and risk-averse investors. Stocks are often considered to be the top investment option for risk-takers, and on the other hand, government bonds are usually the most preferred investment option for risk-averse investors. While it is common knowledge that for investment in stocks you need a Demat account, one of the nagging questions, especially for new investors, is how to invest in government bonds. So do you have this question too? Check out this blog to know how to invest in government bonds and other related information on this asset class.
What are government bonds?
Government bonds, also known as sovereign bonds, are debt securities issued by governments to raise capital from the public to meet fiscal deficits and other developmental activities. These securities are considered to be virtually risk-free as they are backed by a sovereign guarantee and come with fixed maturity periods ranging from a few months to years depending on the nature of the bond. Government bonds are also an excellent source of fixed and stable alternate income source as they provide interest at a fixed rate at periodic intervals which can be quarterly, semi-annually, or annually as per the terms of the bond.
How can investors buy government bonds in India?
Government bonds can be bought by investors through various channels in India. The details of these modes of investment are explained hereunder.
Through stock brokers
One of the most common ways to invest in government securities also known as G-Secs is through your stock broker. Just like investing in any other stock, investors can invest in their target G-Secs through the online portal provided by their stockbroker. It is important to note that similar to stocks, investors need to have a demat account to hold G-Secs as well. The advantage of buying G-Secs through your stockbroker is the knowledge of the investment process, pre-adherence to the KYC requirements as well as ease of managing all the investments under a single portal.
Gilt mutual funds or ETFs
Apart from investing in individual G-Secs, the other easier option to invest in government bonds is through mutual funds that invest specifically in government securities or ETFs that invest in government securities. This is a basket of government bonds that ensures all the benefits of mutual funds as well as tradebility which is the prime feature of ETFs. The other benefit of investing in Gilt Mutual Funds and ETFs is the flexibility of the capital investment that is needed to invest in government bonds.
RBI Retail Direct Scheme
RBI, in 2021, launched the RBI Retail Direct Scheme which enables individual investors to directly invest in G-Secs. Investors have to register to the Gilt Securities Account which is the ‘Retail Direct Gilt’. This account enables the investors to participate in the primary issuance of different types of government bonds and also has no fee for opening or maintaining the gilt account.
This is the platform provided by NSE to participate in the non-competitive bidding facility. This facility is available not only to all eligible investors as permitted by RBI as well as resident individual investors. NSE’s goBID can be accessed through the web portal or mobile application to purchase G-Secs, State Development Loans (SDLs), and Treasury Bills (T-Bills) as facilitated by the RBI. Investors are permitted only a single bid per security in an auction for a minimum amount of Rs. 10,000 (and in multiple of Rs. 10,000 thereof) and the payment for the security can be done through the notified bank account linked to the Demat account or through the UPI option.
Banks and post offices
Government bonds can also be purchased through authorised dealers like notified banks as well as post offices. Investors have to submit the application form for the purchase of their target G-Secs by providing details like the demat account number and other KYC details like the Aadhaar card, PAN Card, and voter card among others. This makes investment in government bonds further accessible to a broad category of investors who may not have access to stock brokers or other dynamic investment portals.
How are government bonds taxed?
Government bonds are in the nature of debt securities and therefore are taxed in a similar manner. Interest income from G-secs (except tax-free bonds) is taxable in the hands of taxpayers as per their applicable slab rates. Income from tax-free bonds is exempt as per Income Tax Act, 1961. Therefore, such income is not subject to any taxation as well as TDS provisions of the Act.
Capital gains on tax-free bonds are not taxable if they are held till maturity. However, if the investor sells tax-free bonds before maturity, capital gains tax will be applicable based on the holding period, similar to taxable bonds.
The capital gains from the sale of government bonds are taxed depending on the holding period. Short-term capital gains from the sale of government bonds are taxed at applicable slab rates while long-term capital gains at taxed at the rate of 20% after giving the benefit of indexation. According to the SEBI classification, gilt mutual funds have to invest a minimum of 80% of the fund in G-Secs across maturities. Therefore, as per the recent amendment in the taxation of debt mutual funds, these funds will be taxed as short-term capital gains at the applicable slab rates irrespective of the holding period.
Why is investing in government bonds attractive?
Investing in government bonds can be a good addition to any investment portfolio as it provides multiple benefits. Some of the advantages of investing in government bonds include
- Safety of investment corpus
- Fixed and stable source of income
- Low volatility investment option as compared to stocks or derivatives
- Diversification of investment portfolio
- Tax benefits of investing in government bonds
- Liquidity of investment
It is widely believed that government bonds are among the most suitable investment options for investors with a lower risk appetite. While this is quite true, investing in these securities is a good option for every class of investor owing to their multiple benefits. The ease of investing in government bonds is further instrumental in increasing their popularity and accessibility. However, investors should also be aware of the lower returns from these bonds as compared to other dynamic investment options like stocks or hybrid funds, etc.
Fixed-rate bonds have a predetermined interest rate throughout their tenure, providing stable returns, while floating-rate bonds have variable interest rates linked to benchmark rates (for example, repo rates), thereby offering the potential for higher returns in changing interest rate environments.
Some of the popular types of government bonds available in India include Sovereign Gold Bonds, 7.75% Government of India Savings Bonds, Zero-Coupon Bonds, State Development Loan Bonds, Inflation-Indexed Bonds, Treasury Bills, Cash Management Bills.
The limitations of investing in government bonds include lower returns which are also taxable (unless investment in tax-free bonds), lock-in period, inflation risk, market risk, interest rate risk, and limited capital appreciation.
Government bonds are issued by the Central or State Government to meet their financing requirements.