Three types of bond investments: Which one suits you the best?
A simple rule to follow about your investments is to only invest in assets when you're comfortable with the risks associated with them.
The best investment strategy is the one you’re comfortable with. If you are up at night thinking about whether your investment will rise or fall, you should re-think your investment strategy. A simple rule to follow about your investments is to only invest in assets when you’re comfortable with the risks associated with them.
When you start to think about allocating your money, one frequent thought that comes to mind is to invest in assets that are not as risky as stocks, i.e. debt or bonds. In simple words, bonds are a way for companies or institutions to raise capital by borrowing money from the public. The bond subscribers get a fixed interest at regular intervals for a defined period.
There are many types of bonds available for investment, but I will cover three types of bonds which lie in Low Risk, Medium Risk and High-Risk.
Government Securities or G-secs
G-secs are used to fund daily operations, unique infrastructure, and military projects.
They guarantee the full repayment of invested principal at the maturity of the security and often pay periodic coupon or interest payments. Since the Govt of India backs these, these are virtually risk-free investments as it has a ‘Sovereign Guarantee.’
G-Secs have long-dated maturities, and the interest is paid semi-annually, i.e., two times a year.
Sovereign Gold Bonds(Low Risk)
SGBs are issued by RBI to enable investors to invest in a substitute for gold. Since the government backs SGBs, it ensures that there will not be any question about default risk, making it relatively safer.
The interest rate for SGBs is 2.5% p.a., and it is paid on a half-yearly basis. The main benefit of investing in SGBs is that you leave the risk of holding physical gold as SGBs are stored in your Demat account.
Also, you don’t need to pay any capital gain tax on redemption of SGB on maturity or after the 5th year. But, there is short-term and long-term gains tax if the SGBs are transferred before maturity.
Covered Bonds(High Risk)
To understand Covered Bonds, we need to understand what a secured bond is. In the case of a secured bond, it is backed by a certain kind of asset(gold, property, etc.), and when a default occurs by the issuer, the bondholders can stake a claim on any of the assets that are backing up that bond.
But what if the company or institution goes bankrupt?
A covered bond solves this. Covered bond is a secured bond with the added feature of bankruptcy protection. The institution here goes one step further to ensure safety. It sells all the underlying loans to the SPV. (A Special Purpose Vehicle (SPV) is a separate entity that is formed to isolate the financial risk from the parent company, i.e., NBFC)
The money directly flows from the SPV to the covered bondholder. Hence, your money does not get stuck in the bankruptcy process.
(The author is co-founder, Wint Wealth; views expressed are personal)