Before choosing government bonds versus bank FDs, an investor must consider a number of factors.
As part of its (and the government’s) aim to encourage retail involvement in government bonds, the RBI has published the characteristics of the Retail Direct Gilt Account.
Is it a good idea to invest in government bonds? In this post, we’ll go through the advantages and drawbacks of such investments. We’ll assume for the sake of this discussion that you’re investing to attain a life goal. We also presume that your favorite bond investment at the moment is bank savings.
Risk of rising interest rates
When you invest in bond mutual funds or any other bond investment that provides capital appreciation, you are subject to interest-rate risk. Bond prices generally fall as interest rates rise, which poses a danger (or in anticipation of rates going up). If you invest in bank deposits, you are not subject to this risk because you only receive interest income.
Direct government bond investment now shields you from interest rate risk as well. How? True, government bonds are traded on the open market and can provide chances for capital growth. However, you can opt to earn solely interest income by holding these bonds until they mature and receiving the government’s par value. You may be required to pay a premium to purchase these bonds. The argument is that you don’t have to worry about bond prices falling during the term of the bond. Government bonds, of course, have no credit risk. As a result, you may count on receiving the par value at maturity.
Risk of reinvestment
Assume you wish to save $15 lakh in ten years. If you have ten lakh now, you must invest in a product that earns 4% per year to amass fifteen lakh in ten years.
Assume you buy a 10-year government bond with a 4-percent post-tax interest rate. It appears that you are well on your way to achieving your objective. However, you have unintentionally exposed yourself to reinvestment danger.
To amass $15 lakh in ten years, you’ll need to earn a compounded yearly rate of 4%. As a result, every year’s interest income must be reinvested at a rate of 4% until the ninth year. The problem is that the RBI might reduce the interest rate in any of the next years.
If you’re interested in a newer investing option, you should invest directly in government bonds. However, if your goal is to achieve a life goal by investing in government bonds, you should keep the following considerations in mind:
First, neither government bonds nor bank deposits (if held to maturity) are subject to interest rate risk.
Second, government bonds put you in danger of reinvestment. If you invest in cumulative fixed deposits (for a big sum of money) and recurring deposits, bank deposits do not (for savings from monthly income).
Finally, bank deposits have a modest risk of default, but government bonds are usually risk-free.