Government securities, commonly called gilt, are debt instruments issued by the RBI on behalf of the Government of India or state governments. It gives a specific rate of interest on a half-yearly basis to the investors. Typically, mutual funds, insurance companies and other institutional investors buy these government securities.
However, the launch of the RBI Retail Direct Platform by the government has made it possible for individual investors to invest directly in government securities, whether it is in the primary market or secondary market. Before that, investors willing to take exposure to government securities had to invest in debt mutual funds that primarily invest in government securities.
So, should you invest directly through the RBI’s platform or in gilt mutual funds if you want to invest in government securities? Here are some aspects you can consider before making the decision.
Through the RBI Retail Direct Platform, one can invest in government bonds, treasury bills, state government bonds and Sovereign Gold Bonds (SGB). You need to carry out different transactions to buy separate instruments.
Currently, no debt funds invest only in treasury bills or gold bonds. However, you can invest in government securities through mutual funds as well. Currently, there are two types of mutual funds that invest primarily in government bonds, i.e., gilt fund and the Gilt Fund With 10-Year Constant Duration. Both these two types of debt funds invest in government bonds with a higher average maturity period.
There is no cost of opening and managing a Retail Direct Account as there is no involvement of an intermediary. As a result, there is no cost at all.
On the other hand, the mutual funds will charge you an annual fee (called the expense ratio) to manage the fund. A debt fund may charge an expense ratio of up to 2% of your total investments as per SEBI regulations. The direct plan expense ratio for most gilt funds, including passively managed funds, ranges between 0.03% and 1.11%.
For instance, the current expense ratio for UTI Gilt Fund – Direct Plan is 0.64%. In other words, the fund will charge you 0.64% of the value of your investment to manage it. Therefore, the fund company will charge you Rs. 6.4 to handle your money if you invest Rs. 1,000 in this scheme.
However, it is important to remember that there are no further fees that the fund house levies on you to manage your money besides this low expense ratio.
Income from government bonds is subject to two types of income taxes. You will be taxed if you make capital gains when you sell government bonds on the secondary market before, they mature. Two, you will also be taxed on the interest you receive from these bonds.
Government bond sales in the secondary market might result in gains or losses in capital. You will make capital gains if you sell the bonds on the primary or secondary market for more money than you paid. On the other side, you will experience capital losses if the price at which the bonds are sold is lower than the price at which they were purchased.
Government bond interest is taxed similarly to interest income from bank fixed deposits. According to the tax structure you have chosen, the interest you receive will be taxed at the rate of income tax that applies to your income.
In contrast, if you invest in government bonds through debt funds and hold them for more than three years, you may qualify for some tax benefits. Gains from holding debt funds for more than three years will be subject to a 20% tax rate with benefits for indexation. However, there would be no tax benefit if you sell your debt fund investments before the three-year mark. The gains will be taxed according to the individual’s tax bracket after being added to income.
So, it is important to consider the post-tax returns of both these investment options before investing in any one option.
Ease of exit
When you invest in government securities directly, you cannot resell these G-secs to the government. To exit these instruments, you have to sell them to other investors who want to invest in these securities. However, you might be unable to liquidate (sell) your shares if there aren’t enough buyers in the secondary market. Moreover, you can also end up losing money if you are forced to sell your government securities at a lower price due to the lack of purchasers.
In comparison, debt funds are more liquid than G-secs. This is because there is a far larger and more developed market for institutional buyers with sufficient trading volume (buying and selling) for G-secs.
Debt investments can help balance the risk in an overall equity-heavy portfolio. Investors can invest directly in debt securities or through mutual funds to take exposure to government securities. Both of these methods come with their own set of pros and cons. Hence, it is better to understand what is important to you and invest accordingly.
Padmaja Choudhury is a freelance financial content writer. With around six years of total experience, mutual funds and personal finance are her focus areas.