Government bonds for investing

Aug 2, 2022

Government bonds for investing

Overview

Bonds are debt instruments in which the investor loans money to an entity. The entity borrows money at a fixed interest rate for a specific time duration. Such an entity can be government, banks or corporate. Hence, when the government issues bonds, they are known as government bonds. Furthermore, these investments are known as fixed income investments.

For people who prefer not to enter the choppy waters of equity markets directly, government bonds and mutual funds are often viewed as the better options. These investors prefer the relative safety of government bonds and mutual funds over the potentially greater returns from directly buying and selling equities. However, many investors find themselves unable to pick between bonds and mutual funds when it comes to deciding upon one out of the two. Moreover, many retail investors remain unclear about how to purchase government bonds and from where to buy government bonds.

Types

There are several types of :??

fixed rate

As the name suggests, the interest rate of these bonds keeps fluctuating during the investment. The interest rate changes are undertaken at intervals which are declared before the bond is issued.

For example, a floating rate bond (FRB) has a pre-announced interval of 6 months. It means that the interest rate would reset every six months throughout the tenure.

Floating rate

As the name suggests, the interest rate of these bonds keeps fluctuating during the investment. The interest rate changes are undertaken at intervals which are declared before the bond is issued.

For example, a floating rate bond (FRB) has a pre-announced interval of 6 months. It means that the interest rate would reset every six months throughout the tenure.

Sovereign gold

Sovereign Gold Bonds have their prices linked to the price of gold  (commodity price). The nominal value of the bond is calculated based on the previous week’s simple average closing price of 99. of purity gold. India Bullion and Jewelers Association Ltd (IBJA) publishes the price list. The denomination of these bonds is in terms of one gram of gold.

The Central Government issues SGBs where investors can purchase gold without a burden of investing in physical gold. Also, the interest on these bonds falls under tax exemption for individual taxation. Furthermore, investors seeking liquidity from these bonds shall need to wait for the first five years to redeem it.

Inflation indexed

The Inflation Index bonds (IIBs) are where the principal amount and the interest payment is linked to an inflation index. The inflation index may be the Consumer Price Index (CPI) or the Wholesale Price Index (WPI). Investments in such bonds ensure real returns which remain constant. Also, it can safeguard the investor’s portfolio against inflation rates.

Call or Put

These bonds come with an option where the issuer has the right to buy back the bond (call option), or the investor can exercise its right to sell bonds to the issuer (put option). The investor or the issuer can exercise the rights only after five years from the date of issue.

zero coupon

As the name suggests, Zero coupon bonds have no coupon payments. The profits from these bonds arise from the difference in the issue price and redemption value. In other words, these bonds are issued at a discount and redeemed at par. Further, these bonds are not issued through auction but created through existing securities.

Advantages

The following are the advantages of investing in government bonds.

Risk-Free

Government bonds promise returns and stability of funds to investors. They have always been an example of risk-free security. Thus, investors looking for a risk-free investment, government bonds are suitable for them.

Returns

The returns from government bonds are generally as good as bank deposits. Also, there is a guarantee of principal along with fixed interest. Unlike bank deposits, these bonds are available for a longer duration.

One can use Scripbox’s returns calculator to estimate their returns.

Liquidity

One can buy and sell government bonds like equity instruments. The liquidity in these bonds is as adequate as banks and financial institutions.

Portfolio Diversification

Investment in government bonds makes a well-diversified portfolio for the investor. It mitigates the risk of the overall portfolio since government bonds are risk-free investments.

Regular Income

As per RBI guidelines, the interest accrued on government bonds shall be disbursed every six months to bondholders. Therefore, it provides an opportunity for the bondholders to earn regular income by investing their idle funds.

Disadvantages

Low Returns

The yield or interest earned on government bonds is relatively lower in comparison to other investment options like equity, real estate, corporate bonds, etc.

Interest Rate Risk

Government bonds are long term investment bonds where the maturity is ranging from 5 years – 40 years. Hence, the bond might lose its value over this period. If inflation rises, the interest rate is less attractive. Also, higher the bond period, the market risk also increases along with interest rate risk. Furthermore, the investor remains with an investment which is paying below the market value.

Should you invest in

If you’re a conservative investor and aren’t worried about beating inflation or low returns and are happy with your money being safe & secure then bonds can be a perfect investment for you. But if you’re looking to make a solid passive income through investments you can choose to invest in something like a Peer to peer platforms like LenDenClub which is hassle free, easy signup and where you can still get consistent high returns on investment allocation done by AI. A P2P model involves diversification of your fund into several small loans to mitigate risk.

Nowadays, there are many investment options available in India. Unlike a few years ago, when FDs and equities were the popular choices among people, various new-age investment options like P2P lending have emerged. The best part about these investments is that they have the ability to balance the risk and returns, which most investors find hard to achieve.

On top of that, online marketplaces like LenDenClub further simplify the process for investors. Let us see how –

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