The sovereign guarantee of a government security is always a big draw. The assured, fixed return it promises provides the foundation for many portfolios. Until now, retail investors took comfort in G-secs indirectly via traditional insurance plans or gilt mutual funds. The RBI Retail Direct platform offers the chance to tap into government bonds directly.
There are some benefits in taking the direct route. First, there is no fee for opening and maintaining the Retail Direct Gilt account or for accessing and transacting on the portal. Investors only have to bear the payment gateway fees. 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, this affords a degree of flexibility not available through other routes.
Long-term government bonds are offering attractive yields
However, DIY investing in gilts comes with own set of complications. Navigating the government securities market is not easy, especially if you are buying from the secondary market and don’t intend to hold the bonds till maturity. While G-secs carry no default risk, they are prone to interest rate risk. In a rising interest rate scenario, these bonds can face sharp mark-to-market losses if sold before maturity. This can test the DIY investor’s resolve. A sharp drop in bond value may unnerve some, prompting a hasty exit at a loss.
How to open RBI Retail Direct Gilt account?
The average small investor will find it much simpler to take the mutual fund route and invest in a gilt fund, insists Suresh Sadagopan, Founder, Ladder 7 Financial Advisories. These come with a diversified portfolio and can manage MTM volatility at their end. Target maturity debt funds adopt the ‘buy and hold till maturity’ strategy. This offers a similar experience to buying and holding government bonds, with predictable returns. By spreading across varying maturity funds, you can create a maturity ‘ladder’ as per your cash flow needs—at better tax efficiency than with individual bonds, points out Rohit Shah, CEO, Getting You Rich.
Guaranteed income plans from life insurance companies are popular as they are offering tax-free yields of up to 6%. For investors, a big hook is that these nullify reinvestment risk over the very long term. They effectively lock in the prevailing rate of return for periods stretching from 15 to 45 years. But liquidity is a key consideration here. In most guaranteed plans, the income does not start flowing immediately. The payouts usually start after the policy term ends—5 to 10 years (for regular payout) or up to 20-25 years (for lumpsum payout). There is no cash flow during the policy term. This severely impinges your liquidity for a long period of time. Sadagopan observes, “Payouts from guaranteed plans happen after a delay, during which your money remains locked in. Most small savings instruments also carry a lock-in. A government bond, on the other hand, will start paying immediately.”
Government bonds pay out interest semi-annually or annually. Further, these can be sold at any time via the RBI portal. However, it is still early days. “It is not yet clear how trading volumes in a retail-centric platform will pan out,” says Sadagopan. Meanwhile, liquidity is readily available when buying via mutual funds. As the mutual fund company itself is the counterparty, liquidity is assured.
Taxability is another dampener. You stand to get no tax relief when investing directly in government bonds. Interest received is added to your income and taxed at your slab. So, at higher tax brackets, this avenue is quite inefficient. If someone in the 30% bracket buys a G-Sec with a coupon rate of 7%, his post-tax yield will be 4.9%. Also, if you sell the bond after one year, you are liable to pay 10% tax on entire gains.
Meanwhile, investors in debt mutual funds enjoy dual tax benefits. Shah argues, “Buying gilts via mutual funds affords several tax benefits which are non-existent when buying government bonds on your own.” When you invest in a gilt fund or target maturity debt fund, you don’t have to pay tax on interest received from underlying bonds. The coupons keep accumulating and get added back to the NAV. You pay tax only when you redeem units in the fund. Further, if you sell a debt fund after three years, the gains get taxed at 20% post indexation.
Investors in traditional insurance plans get more tax benefits. They neither pay tax on the income received nor face any capital gains tax liability. However, investors have to make do with lower return for extended time frames. Besides, the return is not guaranteed, except in guaranteed plans. Among small savings instruments, PPF also offers tax-free, guaranteed return. Interest income from others like NSC, Post Office Monthly Income Scheme, Senior Citizen Savings Scheme is fully taxable.