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Ref. No. KLI/22-23/E-BB/492
Government bonds are debt securities issued by the government to finance spending and obligations.
To prepare for retirement, one should start planning early and invest in post-retirement plans, tools of investment that help create a retirement fund and give returns in the form of regular income once you retire.
Government bonds are debt securities issued by a government to support government spending and obligations. They are loans from investors to the government, which promises to pay back the principal amount on a specified maturity date and periodic interest payments (coupon payments).
Government bonds are issued through auctions. Investors bid on the bonds, specifying the amount they are willing to invest and the yield (interest rate) they expect. These bonds can be issued in various denominations, and the terms can range from short-term (less than a year) to long-term (up to 30 years or more).
Now that you know what are government bonds and how they work, let us understand what are the different types of government bonds in India:
In India, government bonds are crucial for financing government expenditures and managing the country’s economic policy. As the government backs these bonds, they are considered safe investment options.
These bonds differ from fixed-rate bonds as their interest rates are not constant. Instead, the interest rates on FRBs are periodically adjusted based on a reference rate, such as the prevailing market rates or specific benchmarks like the yield on 91-day Treasury Bills.
SGBs are unique instruments that allow investors to invest in gold without physically holding the precious metal. Issued by the Government of India, SGBs are denominated in grams of gold. These bonds provide a safer and more efficient way to invest in gold, eliminating the risks and costs associated with storage and security.
These are designed to protect investors from the eroding effects of inflation. The principal and interest payments of IIBs are adjusted according to inflation rates, usually measured by the Consumer Price Index (CPI).
GOI savings bonds are specifically tailored for individual investors. They offer a secure investment option with a fixed return and often come with tax benefits under certain sections of the Indian Income Tax Act.
These bonds provide flexibility to both the issuer and the investor. A call option allows the issuer to redeem the bond before its maturity date, usually when interest rates decline, making it cheaper to refinance the debt.
Zero-coupon bonds are issued at a discount to their face value and do not pay periodic interest. These bonds are suitable for investors looking for a lump-sum return at a future date and are often used for long-term financial goals such as funding education or retirement.
These are short-term government securities with maturities of up to one year. They are issued at a discount and redeemed at face value, with the difference representing the interest earned.
There are many benefits of investing in government bonds. Some of these benefits are as follows:
Investing in government bonds comes with the assurance of a sovereign guarantee, meaning the repayment of principal and interest is backed by the government. This guarantee significantly reduces the risk of default, making government bonds one of the safest investment options.
Government bonds typically offer regular interest payments, providing a steady and predictable income stream. It primarily benefits retirees or investors seeking consistent cash flow from their investments.
Including government bonds in an investment portfolio helps diversify and reduce overall risk. As they generally have a low correlation with equities and other high-risk investments, government bonds can stabilize portfolio returns during market volatility.
Certain government bonds come with tax benefits, such as exemptions or deductions under specific tax code sections. These advantages can enhance the overall return on investment by reducing the investor’s tax liability.
While government bonds are generally considered low-risk, there are still some factors to consider before investing:
This refers to the possibility that the value of your bond will decline if interest rates rise in the market. When new bonds offer higher interest rates, older bonds with lower rates become less attractive, causing their price to drop.
This risk arises when inflation (price rise) outpaces your bond’s interest rate. Even though you receive your principal back at maturity, its purchasing power might be lower due to inflation.
Though very unlikely, there’s a minute chance of a government defaulting on its debt. However, government bonds are typically backed by the “full faith and credit” of the issuing government, making default a very remote possibility.
Government bonds are generally tradable on secondary markets. However, depending on the specific bond and market conditions, fewer buyers might be available, making it difficult to sell your bond quickly without potentially losing some value.
If you want to invest in government bonds, there are several ways to do so. Here are some of the most popular ways to invest in government bonds:
The RBI Retail Direct program allows individual investors to participate directly in primary issuances of government bonds (G-Secs). To bid on new bond offerings, you can register for a Retail Direct Gilt (RDG) account with the RBI.
You can invest in government bonds on the secondary market through a brokerage house. It involves opening a Demat account and placing buy/sell orders for specific bonds.
Gilt mutual funds invest in a portfolio of government bonds, offering investors diversification and professional management. Some ETFs also track indices of government bonds, allowing investors to gain exposure to the entire government bond market through a single investment.
The tax treatment of government bonds in India can vary depending on the specific type of bond and how you hold it.
You can gain valuable insights into how government bond prices fluctuate and make informed investment decisions by analyzing the following factors:
A strong and growing economy typically leads to lower bond yields (and consequently higher bond prices). Investors are more confident about the government’s ability to repay its debt.
Just like any other security, the price of government bonds is influenced by supply and demand.
If the government issues many new bonds (increased supply), the price of existing bonds may decrease due to lower relative scarcity.
This is a significant factor with an inverse relationship. When prevailing market interest rates rise, the value of existing government bonds with lower fixed interest rates falls. Investors can now buy new bonds with higher yields.
Although very low for government bonds of stable economies, a credit rating downgrade can affect bond prices. A lower credit rating indicates a higher perceived risk of government default, which can lead investors to demand higher yields (and thus lower bond prices).
Government bonds can be a good fit for several investor profiles. Let us take a look at people who should invest in government bonds:
As mentioned earlier, government bonds are a good option for risk-averse investors prioritizing capital preservation over high returns.
Government bonds can provide a steady income stream alongside pensions and social security, making them a valuable addition to a retirement portfolio.
Investors seeking regular income payments may find government bonds attractive, especially compared to the volatility of stock dividends.
Government bonds can be an excellent long-term investment, offering stability and predictable returns over extended periods. It can be helpful for investors with long-term goals like retirement or education savings.
Many institutional investors, such as pension funds and insurance companies, include government bonds in their portfolios due to their low-risk profile and ability to meet long-term liabilities.
Some government bonds, like municipal bonds, offer tax-exempt interest, which can benefit investors in high tax brackets.
Investors with a diversified portfolio may include government bonds to hedge against the volatility of other asset classes, such as stocks. It helps to reduce overall portfolio risk.
1
Yes, Indian government bonds are considered very safe. They are backed by the Government of India’s sovereign guarantee, significantly reducing the risk of default.
2
No, RBI bonds are not entirely tax-free. The interest earned on these bonds is taxable under the investor’s applicable income tax slab.
3
Government bond interest rates in India vary depending on the specific bond’s maturity period.
Some examples are:
4
Yes, government bonds can be used as collateral for loans. Banks and financial institutions accept them as secure collateral due to their low-risk nature.
5
Government bonds can help hedge against economic downturns. They are generally low-risk investments that are more stable than equities and other high-risk assets.
6
Yes, the Government of India offers various schemes, such as Sovereign Gold Bonds (SGBs) and tax-saving bonds, designed to encourage investment in government securities among all investors, including young ones.
Features
Ref. No. KLI/22-23/E-BB/2435