This article is for all of those who are interested in risk free investments for a long period of time.
If you are planning to invest your money for say 20years or 30years in a debt instrument, then, Govt Securities may be a good option.
Let’s know more about them.
- 1 What are Govt Securities?
- 2 Bonds
- 3 Why Govt. issues bonds/securities?
- 4 What are the different types of Govt Securities?
- 5 USP of Govt Secs?
- 6 Who can issue Government Securities (G-Secs)?
- 7 Treasury Bills
- 8 Govt Securities vs Bank FD
- 9 Tax Treatment
- 10 Tenure
- 11 Selling
- 12 Collateral
- 13 How to get T-Bills or Dated Securities?
- 14 Should you buy it?
- 15 Will I invest in them?
What are Govt Securities?
To understand govt securities. Its important to know little bit about bonds.
So what are bonds?
Bonds are debt instruments where investor lends money to an institution (here its Govt. of India) for a fixed period of time at fixed or variable interest rate.
Why Govt. issues bonds/securities?
Govt issues bonds/securities usually for 2 purposes.
a. Raising funds for govt expenditures
b. To cover deficits of annual budget.
In other words, apart from income from taxes and dividends from PSU’s, govt need money to run the country. It need to spend money on infrastructure, social sector schemes etc.
When govt runs short of finances, it asks its bank i.e. RBI for loans. And RBI in turn raises capital by selling T-Bills/Bonds to you and me.
So, indirectly, you are lending to govt. which is obliged to repay you periodic interest and principal at end of tenure.
What are the different types of Govt Securities?
Broadly, There are 2 types of govt securities depending on tenor.
a. Treasury Bills – Loans which govt intends to pay within a year.
b. Dated Securities – Long term loans, which govt intend to pay over many years.
USP of Govt Secs?
Govt Secs are backed up by govt. It comes under debt obligation of the govt.
The guarantee from govt is also known as ‘Sovereign Guarantee’.
Whereas, in Fixed Deposits, its the banks who are liable to pay back your money.
In other words:
G-Secs carry virtually no risk of default and, hence, are called risk-free gilt-edged instruments.
Who can issue Government Securities (G-Secs)?
a. Central Govt. can issue both treasury bills and dated securities.
b. State Govt. can only issue dated securities i.e. State Development Loans
What are Treasury Bills or T-Bills?
T-Bills are short term debt instruments. Treasury Bills are issued for 3 tenors viz. 91days 182 days and 364 days.
T-Bills are zero coupon securities and do not pay any interest on investment.
Then why to invest?
T-Bills are issued at discounted rates than the actual/true/PAR value. While redemption at expiry, they are redeemed at actual/true/PAR value.
Consider, you are interested in a T-Bill of 182 days, having face value i.e. PAR/actual or true value as Rs100/-.
Since, T-Bills are sold at discounted prices by govt., so you got it at Rs95/-. On maturity, you will get the PAR/face/true value i.e. Rs100/-.
Interest earned will be answered after calculating the yield as:
You purchased T-Bill at Rs5/- discount and at price of Rs95/- for 182 days. Therefore,
Yield%=[Discount Offered/Purchase Price]*[365/No. of days of T-Bill]*100.
As a thumb rule, higher the yield, better it is.
What are Dated Securities or Bonds?
Dated securities are issue for long term. Interest earned on them is paid twice annually.
Interest on bonds is known as coupon rate.
Every bond is identified by fixed nomenclature and a International Security Identification Number (ISIN) is assigned to it to identify it uniquely.
The nomenclature consists of coupon rate i.e. interest rate, name of the issuer and maturity year.
For e.g. if a bond has name 8.04%GS2028 then
|Coupon Rate is||8.04%|
|Name of Issuer||Government of India|
|Date of Issue||Nov 16, 2018|
|Maturity||Nov 16, 2028|
|Coupon Payment Dates||Half-yearly (May 16 and Nov 16) every year|
|Minimum Amount of issue/ sale||₹10,000|
For most of the bonds issued by GoI, the coupon rates are fixed.
The bond mentioned in our example has tenure of 10 years with coupon rate of 8.04%. The interest will be paid twice half-annually at the rate of 4.02% in May and Nov. At the end of 10 years, the principal is paid back.
Govt Securities vs Bank FD
Who keeps your money
When you invest in Govt. Securities you are keeping your money with Govt. So, you investment is at risk only when govt defaults, which is in all probability is a rare incident. So, investment in Govt Securities is virtually risk free.
Whereas, when you do bank FD, the onus to pay back your investment rests with bank only. When it comes to defaults, in all probability, banks have higher risks of defaulting w.r.t govt.
So, Govt Securities score here better.
There is not TDS deducted on your investments in Govt Securities. You get back your complete amount at time of interest payments and maturity of T-Bills/Dated Securities. Whatever is the tax liability (if any) you have to claim it by yourself. For T-Bills which you buy at discounted price and sell at par value, earnings are considered as Short Term Capital Gains and taxed as per applicable slab rate.
In case of Dated Securities i.e. Govt Securities, if you hold it for more than 3 years, the gains are considered as Long Term Capital Gains which is 10% flat or 20% with indexation. Otherwise they are considered as Short Term Capital Gains which is applicable as per slab rate.
In case of Bank FD, TDS is deducted on interest payments and taxed as per slap rate.
Bank FD’s can have maximum tenure of 10years, whereas Govt Securities can be purchased for longer tenures like 40 years too. Eg. 7.72% GS 2055 issued in 2015 as 40 years govt security.
Bank FD’s can only be sold in banks, whereas Govt Securities can be sold in secondary markets too. That they can be purchased and sold like stocks. [Coming up]
You can get loans/overdraft on your Bank FD’s. But, Banks FD’s itself have max tenure of 10 years which limit you options to use Bank FD’s as collateral. Whereas, Govt Securities are issued for long tenures, so they can be easily used as collateral for loans.
How to get T-Bills or Dated Securities?
One can buy T-Bills or Dated Securities through auction process. RBI publishes auction calendar in advance.
How auction for T-Bills or Dated Securities work?
It works just like IPO auction. Here the minimum token amount is Rs10,000/- and multiples of it with max value of Rs 2cr/-.
After bidding, allotment is done the bond is listed on exchange for real time trading.
If T-Bill or Security is oversubscribed, then allotment is done on lottery basis.
People who didn’t get allotment in current auction may participate in next auction.
Check here the number of outstanding securities i.e. liabilities of Govt in terms of dated securities as on date.
This was all the raw knowledge about Govt Securities.
Concluding all technicalities, let’s come to opinion.
Should you buy it?
I propose not to buy them.
a. Suppose you invested Rs100000/- say for 30 years at 8% p.a.
Interest earned per year is Rs8000/-
Interest credited every 6 months is Rs4000/-
Ques: Is it useful for you to get Rs 4000/- every month? Does it satisfy any of your goal?
Further, over period of 30 years, you will get Rs8000*30 i.e. Rs2,40,000 as total interest in 60 installments and Rs100000 in return i.e. your invested amount.
The final amount you will get is 1,04,000/-.
What about the purchasing power after 30 years, your purchasing power will be decreased surely i.e. no wealth creation.
Yes they are most secured investment instruments.
If you are about to retire, or already retired, then, you may think investing in them.
Now comes the major question…
Will I invest in them?
I have 2 concerns in it.
a. If I invest Rs10000/- today in a G-Sec, for 20 years time at coupon rate of say 8%. Then, I would be getting Rs400/- half yearly for next 20 years and at end of 20 years I would get back my principal i.e. Rs10,000.
After 20 years, would I be able to buy same items from Rs 10,000 which I am able to buy? Will my purchasing power increase of decrease?
Obviously, with inflation in economy, it is going to decrease.
So, for me, and for most of us its not a good option to invest in Govt Securities.
Read more about managing your personal finance here.