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Suresh Krishnamurthy

INVESTING in government securities (g-secs) has been made easy for the retail investor. For a taxpayer, there is a stronger case now for inclusion of g-secs in a portfolio. There may even be a case for investing surplus savings bank deposits in g-secs with shorter term to maturity.

Still, for a conservative, buy-and-hold retail investor, there is less reason to choose government securities ahead of bank term deposits.

Importantly, the changes likely in the forthcoming Budget need to be considered. If Section 80-L is done away with completely, the case for a small investor who is also a taxpayer gets diluted. In addition, you are locked into an interest rate in the case of investments in a term deposit.

Risks and trading options: However, in a g-sec, if the term remaining till maturity does not match the term to maturity you are seeking, then you are exposed to an interest rate risk.

The case for high-net-worth investors and traders, on the other hand, is stronger. They are in a better position to derive benefits from investing in g-secs than their smaller counterparts. However, even for them, the mutual fund route may be a safer alternative.

That is, however, the case now. Over the long-term, retail trading in g-secs presents even smaller investors with an opportunity to diversify, extend the duration and manage their portfolios better. The introduction of sophisticated instruments, such as inflation-protected g-secs, will enhance their value more.

Term deposits pay: In the trades put through on January 17, the yield to maturity of a five-year g-sec was around 5.66 per cent.

The yield will be still lower if you take into account brokerage costs. However, a term deposit in a bank will pay a minimum of 6.5 per cent for a five-year deposit. There are some banks that even pay 8.25 per cent.

Income from bank term deposits is also eligible for deduction under Section 80-L. So, there is less reason for an investor who is likely to derive interest income of less than Rs 12,000 to invest in g-secs now. This means that if your corpus is less than, say, Rs 1.50 lakh, bank term deposits may be a more suitable option.

Let us say you have more than Rs 1.50 lakh and you are in the 20-30 per cent tax bracket. Then investment of moneys in excess of Rs 1.50 lakh in g-secs is justified. That will provide you a better after-tax yield than investments in bank term deposits. However, even for that, only an investment of up to Rs 50,000 will be justified.

The liquidity angle: For such investors, there is only one reason to invest a lot more in g-secs — their liquidity. G-secs can be liquidated in a day. The penalty for early withdrawal may also not be stiff if there has not been a sharp rise in interest rates. They will even have an opportunity to book profits if interest rates decline. On the other hand, investors will have to pay a penalty in the case of premature withdrawal of bank term deposits.

However, how much are you willing to forego in search of liquidity? The difference between the yields on g-secs and bank term deposits amounts to a stiff penalty for such liquidity.

For example, in the case of a 5-year deposit, the difference is around 1 percentage point. So, unless there is a strong reason to prefer liquidity, investors would be better off choosing bank term deposits as of now.

Suits large investors: Investment in g-secs, however, suits large investors. First, default protection guarantee is available only up to Rs 1 lakh for investment in bank term deposits. On the other hand, every single penny invested in g-secs enjoys the protection of the Central government. They also come with the additional feature of liquidity.

In addition, investors will have the flexibility to design their portfolios in accordance with their risk and return requirements. As such, high net worth investors will benefit more by choosing g-secs ahead of bank term deposits.

However, high net worth investors may need a professional fund manager to manage risks. As such, the mutual fund route, which may be more cost-effective, may be more suitable than directly investing in g-secs through the retail market.

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