Investment word of the day: Whether you’re new to investing or an experienced investor looking to diversify your portfolio, choosing the right type of securities can often be confusing due to the vast pool of options. Among the many investment options available, gilt funds stand out as a notable choice.
Here’s a simple guide to understand gilt funds.
What are gilt funds?
Gilt funds are debt instruments that invest in bonds and fixed-interest securities issued by state and central governments. Also known as G-secs, gilt funds have varying maturities. As these funds are invested with the government, they are believed to carry minimal risk.
How do Gilt Funds work?
When the government requires funding, it turns to the Reserve Bank of India, as the central bank serves as its banker. The RBI provides financial resources to the government by borrowing from institutions such as banks and insurance companies. In return, the central bank issues government securities with a fixed-term loan subscribed by the fund manager of a gilt fund. Once matured, the gilt fund redeems government securities in exchange for cash.
Notably, the performance of gilt funds is influenced by fluctuations in interest rates.
Why gilt funds must be considered by investors
Gilt funds are only invested in government securities. Hence, they are considered to be low-risk investments with consistent returns, suitable for those who prefer lower risk and conservative investors.
Points to be noted when investing in gilt funds
Interest rates
Gilt funds mainly invest in government securities (G-secs) and are hence susceptible to interest rate changes. When interest rates increase, the value of the bonds in the fund falls, leading to a decline in the net asset value (NAV) of the fund. Meanwhile, NAV increases when interest rates fall.
Expense ratio
In order to cover operational expenses, gilt funds typically charge an expense ratio. This amount may differ across various funds.
Taxation
Capital gains generated from gilt funds are taxable. The rate of taxation depends on your holding period, which is the time period invested in a gilt fund. A capital gain realised within less than three years is termed a short-term capital gain (STCG). In contrast, a capital gain incurred after three years or more is called a long-term capital gain (LTCG).
Disclaimer: This story is for educational purposes only. The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.