Sovereign guarantees of government security are always a big draw. It promises assured, fixed returns that provide the basis for many portfolios. So far, retail investors have taken rest g second Indirectly through traditional insurance plans or gilts mutual funds, NS RBI Retail Direct The platform offers an opportunity to directly tap into government bonds.
There are some advantages to taking the direct route. Firstly, there are no charges for opening and maintaining a Retail Direct Gilt account or for accessing and transacting on the portal. Investors will have to bear the payment gateway charges only. Debt mutual funds and traditional insurance plans come at a cost. Second, direct investors can pick and choose specific bonds as per their cash flow needs. For DIY investors, it offers a degree of flexibility not available through other routes.
Long term government bonds giving attractive returns
However, with a DIY investment in gilt come a number of complications. Navigating the government securities market is not easy, especially if you are buying from the secondary market and do not intend to hold the bond until maturity. While government securities carry no default risk, they are prone to interest rate risk. In a rising interest rate scenario, these bonds may face sharp mark-to-market losses if sold before maturity. It can test the resolve of the DIY investor. A sharp drop in bond value may bother some, indicating a hasty exit at a loss.
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How to open RBI Retail Direct Gilt Account?
Suresh Sadagopan, Founder, Ladder 7 Financial Advisory, says it would be easier for the average small investor to go the mutual fund route and invest in gilt funds. These come with a diversified portfolio and can manage the MTM volatility on their end. Target Maturity Debt Funds follow a ‘buy and hold till maturity’ strategy. It provides a similar experience of buying and holding government bonds with predictable returns. Rohit Shah, CEO, Getting You Rich explains that by spreading out across different maturity funds, you can build a maturity ‘ladder’ as per your cash flow needs-at better tax efficiency than individual bonds.
Guaranteed income plans from life insurance companies are popular as they offer up to 6% tax-free income. For investors, a big hook is that these greatly reduce reinvestment risk over the long term. They effectively lock in the prevailing rate of return for a period ranging from 15 to 45 years. But liquidity is an important consideration here. In most of the guaranteed plans, the income does not flow in immediately. The payouts usually start after the end of the policy term- 5 to 10 years (for regular payouts) or up to 20-25 years (for lump sum payments). There is no cash flow during the policy term. This seriously affects your liquidity in the long run. “Payments from guaranteed schemes are post-delay, during which your money is locked in. Most small savings instruments also have lock-in. A government bond, on the other hand, will start paying off immediately,” says Sadagopan.
Government bonds pay interest semi-annually or annually. In addition, these can be sold at any time through the RBI portal. However it is still early days. “It is not yet clear how trading volumes will increase in retail-focused platforms,” says Sadagopan. Meanwhile, liquidity is easily available when making purchases through mutual funds. Since the mutual fund company itself is the counterparty, liquidity is assured.
Taxability is another moisture. You do not get any tax relief by investing directly in government bonds. The interest received is added to your income and taxed at your slab. Therefore, in higher tax brackets, this avenue is quite inefficient. If someone in the 30% category buys a G-Sec with a coupon rate of 7%, his after-tax income will be 4.9%. Also, if you sell the bond after one year, you are liable to pay 10% tax on the entire gain.
Meanwhile, investors in debt mutual funds enjoy double tax benefits. Shah argues, “Buying gilts through mutual funds offers several tax benefits that are not present when buying government bonds on their own.” When you invest in gilt funds or target maturity debt funds, you do not have to pay tax on the interest earned from the underlying bonds. Coupons keep on accumulating and get added back to the NAV. You pay tax only when you redeem the units in the fund. Also, if you sell a debt fund after three years, the post-indexation gain is taxed at 20%.
Investors get more tax benefits in traditional insurance plans. They neither pay tax on the income received nor face any capital gains tax liability. However, investors will have to make do with diminishing returns for the extended time frame. Also, except in the guaranteed plans, the returns are not guaranteed. Among small savings instruments, PPF also offers tax-free, guaranteed returns. Interest income from NSC, Post Office Monthly Income Scheme, Senior Citizens Savings Scheme among others is fully taxable.