RBI Retail Direct – Bank FDs Vs Govt Bonds

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After the launch of RBI Retail Direct, the big question that comes to our mind is which is best option between Bank FDs Vs Govt Bonds. On 12th November 2021, RBI launched a platform called RBI Retail Direct to open a Gilt Security Account with the RBI and purchase Government of India Bonds in the primary and secondary market without a fee.

RBI Retail Direct - Bank FDs Vs Govt Bonds

Now all are eager to experiment with this platform. However, there is a huge difference between investing in Bank FDs Vs Govt Bonds. Hence, let us try to understand the difference between a Bank FD Vs Govt Bonds and who can actually buy such bonds.

RBI Retail Direct – Bank FDs Vs Govt Bonds

I have already written a post on the features of RBI Retail Direct and you can refer to the same at “RBI Retail Direct – Invest in Government Bonds online“.

# Safety

When it comes to the safety of investment between Bank FDs Vs Govt Bonds, Government Bonds are safer. The reason is that in the case of Bank FDs (except Post Office Term Deposits), if your bank goes bankrupt (which has not happened as of now with respect to Public Sector Banks), then the maximum limit of money you get back is Rs.5 lakh (as per the DICGC). This Rs.5 lakh is inclusive of interest and principal together for each bank for each investor (The deposits kept in different branches of a bank are aggregated for the purpose of insurance cover and a maximum amount of upto Rupees five lakhs is paid.).

However, in case of Government Bonds or Gilt Bonds, Government is the issuer and hence safetywise Government Bonds are far safer than Bank FDs.

# Liquidity

In case of Bank FDs, if you booked the FDs using the internet banking facility, then even before maturity, you can withdraw it instantly even in the midnight also. But if you booked the FDs through offline mode, then you have to visit the branch to liquidate the same. There will be a premature withdrawal penalty charged by banks.

However, in case of Government Bonds liquidity is not so easy. Eventhough trading platform is available, selling bonds depends on number of buyers at that time. The price of long term bonds are highly volatile in nature in secondary market. Hence, selling these Government Bonds if you need the money easy not so easy as in some cases they are traded thinly and in some cases you may unable to find the right price due to volatility.

# Taxation

Taxation of FDs are as per your tax slab. However, if you not submit the Form 15G/15H, then Banks will deduct the TDS on yearly basis and you have to file ITR later to claim such TDS (if your tax liability is lesser than the TDS rate and if it is more, then you have to pay additional tax. The tax rate on FDs is as per your tax slab.

In case of Government Bonds, you have to look into two aspects of taxation. One is the coupon (interest what you receive on regular basis) and what if you sell before maturity.

If you are not selling before maturity, then the interest (coupon) received by these bonds are taxable as per your tax slab. You have to pay the tax on yearly basis (even though there is no concept of TDS).

However, if you are selling the bonds before maturity in the secondary market, the rate of taxation is based on your holding period, i.e. how long you stay invested in a bond. A capital gain made during less than three years is known as the short-term capital gain (STCG). A capital gain made over three years or more is known as the long-term capital gains (LTCG). Investors will receive the STCG from bonds, and he should pay the income tax at 10%. LTCG tax, on the other hand, is a flat 20% with indexation benefits.

# Returns

When it comes to Bank FDs, you know very well in advance the returns you are getting from the FDs. However, in case of Government Bonds also, you are assured of coupon (interest) which Government will pay you on regular basis up to the maturity.

However, the risk of Government Bonds will arise if you try to sell it in a secondary marked before maturity. Here, the concept of YIELD will comes into picture.

Yield measures the return on your investment on an annualized basis.

Yield = Coupon amount/price. When the price changes, so does the yield.

Here’s an example: Let’s say you buy a bond at its Rs.1,,000 par value with a 10% coupon (annaul interest).

If you hold on to it, it’s simple. The issuer pays you Rs.100 a year for 10 years, and then pays you back the Rs.1,000 on the scheduled date. The yield is therefore 10% (Rs.100/Rs.1,000).

If, however, you decide to sell it in the secondary market, then you may or may not get back the invested Rs.1,000. Because bond prices change on a daily basis of prevailing interest rates.

If the price of the bond in the market is Rs.800, it’s selling under face value or at a discount. If the price of the bond in the market is Rs.1,200, it’s selling above face value, or at a premium.

Regardless of the market price of a bond, the coupon remains the same. In our example, the bond holder continues to receive Rs.100 a year.

What changes is the bond yield. If you sell it for Rs.800, the yield will be 12.5% (Rs.100/Rs.800). If you sell it for Rs.1,200, the yield will be 8.33% (Rs.100/Rs.1,200).

YTM is one more concept which you have to understand if you are trying to buy from the secondary market. YTM simply means as per the current bond price, what will be your return on investment if you hold the bond till maturity.

Hence, if you are planning to hold the government bond till maturity, then you no need to worry about market flactuation or yield. You are guaranteed of interest till maturity and no risk at all. However, if you are planning to sell in the secondary market then the yield will comes into picture, which again depends on volatility measures like maturity period, interest rate cycles and liquidity.

# Interest Rate Payout

In case of FDs, you have an option to chose the interest payout like either on quarterly or yearly or at maturity. However, currently in case of Governent Bonds, as of now, there are no such cumulative bonds available (means you will get principal and interest at maturity). Hence, usually Government Bonds will pay you the interest usually twice a year.

Hence, investing in such Government Bonds is suitable only for those who are looking for some GUARANTEED long term interest income (like pension or annuity). If your idea is to invest and make it grow, then such Government Bonds are not suitable for you.

Instead, you can use Gilt Bonds or NPS Tier 2 Government Bond options.

To understand how volatile the Gilt Bonds prices, I have considered the SBI Gilt Fund data of alst 20 years. It is one among the oldest Gilt Mutual Fund with considerable high AUM. Hence, I have considered this to show you the volatility of such Government Bonds.

Gilt Bodns Volatility

Notice that for each 3 years, 5 years and 10 years holding periods how volatile are the returns. Why I am considering Gilt Bond Fund instead of Gilt Bonds data? As of now, I am unable to find the historical Gilt Data. Hence, to show you the way how volatile are Gilt Bonds, I have taken into consideration of Gilt Bonds.

Conclusion :- Considering all these aspects, what we can assume that Government Bonds are not alternatives to Bank FDs. They have their own positives and negatives. Hence, instead of jumping into investing BLINDLY just because RBI launched the platform for you, it is better at first to undrestand your purpose of investment and if the above said points are suitable for your consideration, then go ahead and invest in Government Bonds. Otherwise, for short term (like less than 3 years), FDs are still the best choices and for for long term, I prefer Gilt Bonds (if your holding period is more than 10+ years).

However, if someone is looking for safe kind of constant stream of income (without worrying the liquidity) for 10, 20 or 30 years period, then you can consider such Government Bonds (Don’t forget the inflation).

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5 Responses

  1. Good article on the fundamental concepts of the Government Bonds.
    Also, it is good to see that, you have highlighted the volatile nature of such long term bonds, based on interest rate movement.
    One need to keep in mind that, this Retail platform has been launched at a time, when fiscal deficit has widened over last year, and due to low interest rates the bond yields are close to only 6%. Probably, retail investors are better off investing the short & medium term funds in Bank FD, and invest in such bonds when yields are more attractive.
    Also, Liquidity could be very less in the secondary markets.
    So retail investor need to be cautious while investing funds in these bonds, for long term. This is based on my understanding and I could be wrong as well.

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