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All You Need to Know About Pros and Cons of Government Bonds

Personal Finance

Investments are a must when it comes to financial planning for you and your family. With well-planned low-risk investments, you can slowly see your money grow. And with long-term goals in the vision, investing in government bonds can help you fulfil all your dreams.

While investment is often seen as risky, investing in government bonds is simple and risk-free. But before you invest your hard-earned money in government bonds, here are the pros and cons of investing in government bonds.

What are government bonds?

Before deciding whether or not to invest in a government bond, it is essential to know what a government bond is. A government bond can be defined as a debt instrument that the Central and State Governments of India issue from time to time. The issuance of government bonds occurs when the issuing authority (State/Central Government) faces a financial crunch. Issuance of government bonds is a way for the government to raise funds.

Be it in any form, a government bond is an agreement between the issuer and the investor. The issuer guarantees the payment of interest on the face value of the investment along with repayment of the principal value at the end of the investment tenure. On the other hand, the investor pays the desired principal investment.

Government bonds fall under the umbrella of government securities or G-Sec. They are issued for 5 to 40 years. They are considered long-term investment tools.

While government bonds were initially issued for large investors. But eventually, they were offered to small-scale investors such as individuals as well. Interest provided by a government bond is called a coupon. It can be either floating or fixed. It can be disbursed on a semi-annual basis. Generally, these bonds offer a fixed coupon rate.

Types of government bonds

There are multiple kinds of bonds issued by the Indian Government. They cater to different investment objectives. Here are the most common types of government bonds in India:

Fixed-rate bonds

As the name suggests, Fixed-Rate Bonds offer a fixed rate of interest. This interest remains constant throughout the entire investment tenure. This rate does not fluctuate as per market rates.

Floating rate bonds

Floating Rate Bonds are bonds that offer a floating rate of interest throughout their tenure. The change in the rate of interest occurs at predefined intervals declared before the bond is issued.

Another variant of FRBs is where the interest rate is divided into two components: a fixed spread and a base rate. This spread is determined through an auction and remains fixed throughout the maturity tenure.

Sovereign gold bonds

Sovereign Gold Bonds or RBI Sovereign Gold Bonds offer gold investments without the burden of physically possessing the gold invested in. The best feature of an RBI Sovereign Gold Bond is that the interest earned on such bond is exempted from tax.

The price of such bonds is linked to the market price of gold. Published by the India Bullion and Jewellers Association Ltd (IBJA), the price of this bond is per one gram of gold. This price is determined by calculating the previous week’s simple average price of 99.99% pure gold.

As per the RBI, there are individual ceilings on SGB possession for different entities. The interest rate for RBI Sovereign Gold Bonds is fixed at 2.50 % per annum. It is payable semi-annually on the nominal value. The fixed maturity period of SGBs is eight years. Investors seeking liquidity from these bonds must wait for five years before redemption.

Treasury bonds

Treasury bonds are also called treasury bills or T-Bills. They are short-term bonds issued by the Government. The RBI issues these bonds to tackle the short-term fund requirements of the government. Treasury bonds have 0 coupon rates. However, investors can purchase these bills at a discount on the face value of these bonds. During redemption, the entire face value is returned to the investor. Treasury bonds are issued in four categories, i.e. 14, 91,182 and 364 days.

Pros of Investing in Government Bonds

Here are the advantages of investing in government bonds:

Guaranteed returns

When compared to other investment options, government bonds are considered to be the safest. This is because government bonds come with a promise of guaranteed returns. And this promise is from the Government itself.

Inflation Proof Investment

Investments made in Inflation-Indexed bonds are indexed against increasing average prices. Moreover, the investment made in Capital Indexed Bonds is also inflation adjusted. This allows investors to be less prone to being financially undermined.

Regular income

As per RBI, interest earned on Government Bonds must be paid every six months. This offers an opportunity for investors to earn regular income.

Cons of Investing in Government Bonds

Despite its pros, here are the cons of investing in government bonds:

Low-interest rate

The biggest con of government bonds is that they offer lower interest rates. Other than the 7.75% GOI Savings Bond, interest rates are competitively lower.

Fading of relevancy

With investment tenure ranging from 5 to 40 years, government bonds’ investments can lose relevancy as time passes. Unlike inflation and capital-indexed bonds, other government bonds tend to lose their value in the face of inflation.

The Bottom Line

Government bonds are one of the safest investment options. Government bonds offer higher than the average interest rate and are perfect for diluting your overall investment risk. If you are a risk-avoiding investor, then government bonds are indeed for you.

So this was all about the pros and cons of government bonds. If you want professional investment and financial knowledge, visit the Parimal Finance blog and be a better investor. For all your personal loan needs, visit the Parimal Finance website and give wings to your dreams.