Investing 101 for Low-risk Investors - Types of Government Securities They Can Invest In

Investing in the financial markets can be daunting, especially for those with a low-risk appetite. Government securities (Gsecs) offer a comparatively safer and reliable investment avenue for such investors, as opposed to investing in direct equity which has a high risk.

This article will explore the meaning of government securities, provide an overview of different types, explain how they work, their taxation requirment, and discuss its advantages and disadvantages.

Government securities meaning

Government securities, often referred to as govt. securities or Gsecs, are debt instruments issued by the government to finance its fiscal deficit. These securities are considered low-risk investments as they are backed by the government's creditworthiness. They offer a fixed interest rate and a predetermined maturity period, making them an attractive option for conservative investors.

How do Gsecs work?

Understanding how govt securities work is crucial for investors. When you invest in a Gsec, you are essentially lending money to the government for a specified period. In return, the government promises to pay you interest at regular intervals and repay the principal amount at maturity.

For example, if you buy a 10-year government bond with a face value of ₹1,000 and an assumed annual coupon rate of 7%, you will receive ₹70 as interest every year for 10 years. At the end of the 10-year period, you will get the principal amount of ₹1,000.

Different types of Gsecs for investors with a low-risk appetite

Various types of government securities cater to different investment needs and risk profiles. Here are the main types:

1. Treasury bills (T-bills): These are short-term debt instruments with maturities of 91 days, 182 days, or 364 days. T-bills are issued at a discount to their face value, and investors receive the face value upon maturity.
2. Government bonds: These are long-term debt instruments with maturities ranging from 5 to 40 years. They pay periodic interest (coupons) to investors and return the principal amount at maturity.
3. Cash management bills (CMBs): These are similar to T-bills but have a shorter maturity period, typically less than 91 days. CMBs are issued to meet temporary cash flow mismatches of the government.
4. State development loans (SDLs): These are bonds issued by state governments to fund their development projects. They offer a slightly higher interest rate as compared to central government bonds.
5. Sovereign gold bonds (SGBs): These are government securities denominated in grams of gold. They offer a fixed interest rate and provide an alternative to physical gold investment without the associated storage and security risks.

How to invest in government securities?

Investing in government securities has become more accessible in recent years. Here are the primary ways to invest in Gsecs:

1. Primary market: You can participate in auctions conducted by the Reserve Bank of India (RBI). These auctions are open to individual investors, institutions, and banks. You can place bids through your bank or a primary dealer.
2. Secondary market: Gsecs can be bought and sold on stock exchanges like the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). You need a demat account and a trading account with a registered broker to trade in the secondary market.
3. Gilt mutual funds: These are mutual funds that invest primarily in government securities. They offer an easy way to gain exposure to Gsecs without directly buying them. Gilt funds are managed by professional fund managers who make investment decisions on behalf of investors.

How are government securities taxed?

As an investor, it is crucial for you to understand Gsec taxation. The interest earned on Gsecs is taxable as per your income tax slab. However, there is no tax deducted at source (TDS) on the interest earned from these securities.

For example, if you fall in the 20% tax bracket and earn ₹10,000 as interest from Gsecs in a financial year, you will need to pay ₹2,000 as tax on this interest income. Advantages and disadvantages of investing in Gsecs

Government securities offer several benefits, but they also have some drawbacks. Here are the main advantages and disadvantages.

Advantages

1. Low risk: Gsecs are considered one of the safest investment options as they are backed by the government.
2. Fixed returns: They offer a fixed interest rate, providing a predictable income stream.
3. Liquidity: Gsecs are highly liquid, and you can easily buy or sell them in the secondary market.
4. Diversification: Including Gsecs in your investment portfolio can help diversify risk and stabilise returns.

Disadvantages

1. Lower returns: Compared to other investment options like equities, Gsecs generally offer lower returns.
2. Interest rate risk: The value of government securities can fluctuate with changes in interest rates. When interest rates rise, the value of existing Gsecs may fall.
3. Reinvestment risk: If you invest in short-term Gsecs like T-bills, you may face reinvestment risk when the securities mature, especially if interest rates have declined.

Conclusion

Government securities provide a low-risk investment option for conservative investors seeking stable returns. By understanding the different types of Gsecs, how they work, and the advantages and disadvantages, you can make informed investment decisions. Whether you invest directly in Gsecs or through gilt mutual funds, adding government securities to your portfolio can enhance its stability and diversification.

Disclaimer: This article is for informational purposes only and does not constitute financial advice. It is not produced by the desk of the Kotak Securities Research Team, nor is it a report published by the Kotak Securities Research Team. The information presented is compiled from several secondary sources available on the internet and may change over time. Investors should conduct their own research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.

Investments in the securities market are subject to market risks, read all the related documents carefully before investing. Please read the SEBI-prescribed Combined Risk Disclosure Document before investing. Brokerage will not exceed SEBI’s prescribed limit.