Government Bonds - An Alternative to Bank Deposits!

Have you ever considered investing your hard-earned money in the market but are unsure how to get started? You could be someone who has already invested in the stock market but is seeking new opportunities.
Who doesn't want their money to increase? Stock market can provide great returns on investments, but we all know how risky investing in the stock market is. Contrary to this, a bank's savings account can provide a safety cushion, but the returns on such investments are minimal.

Is there an investment option which is safe and also provides higher interest rates than a bank FD? The answer is "Bonds".

What are Bonds?

A Bond is an instrument for lending money to a borrower (in this case a company or a government organization) where principal and interest are fixed and that is why it is also termed as a "fixed income source". Bonds are a legal agreement between a lender and a borrower.

Let us understand bonds with the help of an example :

Assume there is a bond with a face value of $100 and the company has promised you to pay 8% coupon rate (interest rate) on it with maturity of 5 years.

You invested $100 and signed an agreement with the company.

Now you will receive the interest periodically and will get your principal back at the time of maturity. Sometimes, both interest and the principal amount are returned to the lender at maturity. The period for payment of coupon rates varies depending on the company and its agreement. So, before you invest, make sure to read all the terms & conditions.

Different Types of Bonds-

Bonds are mainly classified into 2 types :

1. Corporate Bonds : Private corporations offer these debt securities. (Ex- ICICI Prudential Corporate Bond Fund)
2. Government Bonds : A government bond is a debt security issued by the government to fund its expenses and commitments (e.g. Treasury Bills).

Now the question is, if the government or private enterprises require finances, why don't they take out a loan from a bank?

The basic answer is that there is a lot of paperwork and restrictions when taking out a loan from a bank, which is not the case with bonds. Therefore, companies prefer issuing bonds for collecting funds as it is faster and convenient

Why does the government need funds? The government may require funds for several reasons, including funding infrastructure and social welfare initiatives such as roadways, railways, ports, urban and rural development, and so on.

Pros of Investing in Government Bonds :

1. Government bonds are preferred over corporate bonds due to their low risk because government securities are a formal declaration of the government's debt commitment; they represent the issuing governmental body's duty to repay according to the terms specified. It is the finest investment option for individuals who do not want to incur risks with their finances.
2. Government securities are available in a variety of maturities ranging from 91 days to 40 years to meet the needs and goals of different individuals and organizations (Source).
3. Government bonds provide higher liquidity than stocks. Anyone can readily sell a government bond in the secondary market to meet their financial needs.
4. Bonds issued by governments can also be used as collateral when borrowing money.

Cons of Investing in Government Bonds :

1. Corporate bonds may be a better long-term investment alternative than government bonds, as government bond values lose relevance faster when faced with the prospect of inflation.
2. Corporate bonds have a coupon rate of 7% to 12%, whereas government bonds have a coupon rate of 6%-8% (Source).

Factors to consider while investing in Bonds :

1. Maturity Date : Assume Shreya wants to buy a house and wants a 10% return on her investment in the next 8 years. She discovered a bond with a 10% return, but the maturity date is ten years away. As a result, this bond will not meet her financial goals in a timely manner. This is a key consideration when investing in bonds.
2. Risk Capacity : Before investing in bonds, one should carefully investigate the entity issuing the bond. Is default a possibility? How much money has the entity already borrowed? All these issues must be considered.
3. Buy-Back Option in Bonds : When bonds trade at less than their par value, the issuer contacts bondholders and offers to buy the bond back. Bond investors may face difficulties because of this as it can affect their financial goals.
4. Ratings : Major rating agencies such as CRISIL, Moody's, Fitch, and others frequently evaluate a company's capacity to function and repay debt. Ratings vary from AAA (excellent credit) to D (default). Bond yields are significantly impacted by the ratings of these companies. As a result, before investing in bonds, always check the rating.

The factors described above are the major ones which affect an investor’s decision to invest in a particular bond. However, there are many more that should be considered before investing in Bonds, even if you are investing in government bonds.

Conclusion :

Bonds are a safer investment option with a better ROI compared to bank deposits. However, proper research should be done before investing in Bonds in order to make investment decisions which are aligned with an investor’s financial goals. An investor should approach a professional for help if they are not well versed with the nuances of Bonds.

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