Friday, November 21, 2008

Why you should prefer Gilt investments to FDs?

What is Gilt?
Gilt or G-Sec are instruments issued by the Reserve Bank of India (RBI) on behalf of the government and include central and state government securities, as well as short-term treasury bills issued as part of the central bank's open market operations.
How can we invest?
Gilt Mutual Funds: Retail investors can take exposure to Govt. bonds through Gilt funds - mutual funds that invest in G-Secs and money market instruments. Over the past one year, medium- and long-term gilt funds have been the best performing category among debt funds. Some top-rated gilt funds are giving a return of over 20 per cent.
What are the risks when investing in Gilts?
On any fixed income investment (Gilt, Corporate bond, or Fixed Deposit in a bank) there are three types of risks - Credit risk, Liquidity risk and Interest rate risk.
G-Sec has practically zero credit risk (guaranteed by Govt.) and good liquidity. However, they do have interest rate sensitivity like any other fixed instrument - there is an inverse relationship between interest rates and prices of securities. Therefore, if the interest rate goes down, the prices of bonds rise and vice versa. Interests on these bonds are normally paid semi-annually on the face value, and are one of the sources of earning from these papers.
Gilt Mutual Funds – Tax efficient than FDs
Gilt funds get the same treatment as debt funds and are thus, eligible for the benefit of indexation on capital appreciation. Dividend received, if any, is chargeable to tax at 14.16% (12.5% + 10% surcharge + 3% education cess). In bank FDs, one has to pay tax on the interest earned at the end of a financial year even if the interest would be paid at a later date, or maybe years later. For example -you have made an FD of Rs 50,000 for four years. You will have to pay tax on the liable interest for all the financial years it spans, even though the interest amount would come into your hands only at the end of the four-year tenure.
Also, if the interest on a particular fixed deposit exceeds Rs 10,000, you would be liable to tax deduction at source (TDS), which is applicable per financial year. The bank will compute your interest and will deduct an amount equivalent to the tax, if any, by making adjustments in the FD amount.

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