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Gilt Funds Vs Bank Fixed Deposits – Which is best?

If the choice is between Gilt Funds Vs Bank Fixed Deposits, then which one is best and safe? What are the risks in Gilt Funds and Bank Fixed Deposits?

Currently, the 10-year Government of India’s Bond Yield is hovering around 7% and many Banks offer around 7% interest rate for 10-year Fixed Deposits. Hence, obliviously the question mark in many investors’ minds is which one to choose. Let us try to discuss this aspect.

Gilt Funds Vs Bank Fixed Deposits

Gilt Funds Vs Bank Fixed Deposits – Which is best?

There are various risks when it comes to Gilt Funds or even Bank Fixed Deposits. Hence, let us try to understand them one by one in detail.

1) Credit Risk

Let us try to understand the nature of Gilt Funds. As per the definition, they have to invest around 80% of your money into Government Of India Bonds. Rest 20% is left with the fund manager to choose. It is your responsibility to check where the fund manager is investing the remaining 20% of the portfolio.

This rule applies to both Gilt Fund and Gilt Constant Maturity Fund (where the fund manager has the mandate to hold 10 years of maturing government bonds).

If the fund manager is holding the whole portfolio in Gilt, then the probability of default is almost NIL. Mainly because if the Government Of India default means obliviously many banks also may be in trouble. Hence, for that matter let us have faith that such an event will not happen (not happened earlier also).

In the case of Bank FDs, the maximum security is Rs.5 lakh under the Deposit Insurance and Credit Guarantee(DICGC). Along with this, once a year RBI publishes the banks’ list which is classified as Domestic Systemically Important Banks (D-SIBs) or institutions which are ‘too big to fail’. Under this list, SBI along with HDFC Bank and ICICI Bank are there. You can refer to the latest press release in this regard HERE.

Hence, if you are looking for less than Rs.5 lakh investment then any bank which is covered under DICGC is fine. However, if your investment is more than Rs.5 lakh, then better to invest among these three banks or in the banks which are listed by RBI under Domestic Systemically Important Banks (D-SIBs) or institutions which are ‘too big to fail’.

Post Office Deposits also have sovereign guarantees. However, you can’t invest for the long term in Post Office Term Deposit as the maximum tenure is 5 years.

2) Volatility Risk

In terms of Bank FDs, you will not face any volatility risk as you are assured of a return of principal with fixed interest.

However, in the case of Gilt Funds, they may be highly risky (especially Gilt Constant Maturity Funds) based on the tenure of the bond. Do remember that when someone is saying 10 Year GSec YTM is at 7%, then it means that if you are investing today and HOLDING TILL MATURITY, then this 7% is a reality. However, the journey of these 10 years is filled with up and downs where your invested amount may go up and down based on the interest rate cycle.

Also, holding a 10-year maturing bond is different than holding a gilt fund which is holding 10-year gilt. Because in the case of bonds, volatility will slowly reduce as the maturity is nearer. However, in the case of gilt funds, as they don’t have any maturity, after 9 years of your investment period also (just for example for 10 years holding period), the fund may be holding a 10 years or more than that maturity government bonds.

Hence, in the case of gilt funds, the volatility is always there. Assume that your investment period is around 10 years and you are investing in Gilt Constant Maturity Fund (where the fund manager has a mandate to invest in 10-year maturing bonds), this does not mean that as your requirement is nearer, the risk will get reduced like the bond holding. Because the fund manager will continuously have to hold 10-year maturing bonds.

Hence, you must slowly come out (as the goal is nearer) from gilt funds to short-term funds to reduce the volatility. Otherwise, you may end even with negative returns also if there is a drastic change in the interest rate cycle during your need.

3) Taxation

After 1st April 2023, you may be aware that Debt Funds are also taxed like Bank FDs. If you are unaware of this development, then refer to my earlier post “Debt Mutual Funds Taxation from 1st April 2023.

However, the only advantage with respect to debt funds is that you have to pay the tax only when you withdraw the money. However, in the case of FDs, you have to pay the tax on a yearly basis or there will be a TDS.

Hence, I prefer Debt Funds even though the tax rate is the same in both FD and Debt Fund cases.

4) Liquidity

In the case of liquidity, even though you can break the FDs at any point in time, you have to pay the premature penalty. However, in the case of Gilt Funds, you can withdraw at any point in time. However, you have to bear the volatility risk. If during your need, the returns are less due to the volatility of interest rate, then you have to convert your unrealized gain or loss into realized gain or loss.

Hence, in the case of Bank FDs, you are aware that what return you will get even if you wish to break before maturity (post-penalty). However, in the case of Gilt Funds, as they are market linked, you can’t predict the same way.

Another way to manage the liquidity in FDs is by splitting your FDs into various amounts rather than having a single FD. For example, if you wish to deposit around Rs.25 lakh of FD, then rather than a single Rs.25 lakh FD, make sure to have around five FDs of Rs.5 lakh each.

5) Returns

As I have mentioned above, even though the current yield of a 10-year bond is around 7% and bank FDs also offer you around 7% returns, we are unsure of whether you get around 7% from Gilt Funds.

Mainly because as I have explained above, holding a 10-year bond is different than holding a long-term investing gilt fund.

Even though we may assume that Gilt funds can easily beat the 10-year Bank FD rate over the long term, we can’t say firmly as Gilt Funds are market linked.

Considering all these options, go for Gilt Funds only if you are aware of the volatility risk and ready to come out from these funds well in advance. If you don’t know when to come out, then I suggest Target Maturity Funds over Gilt Funds (especially when you know the exact goal time horizon). Because in the case of TMFs, as maturity is fixed, the volatility risk will reduce slowly by default, and you do not need to switch to short-term bonds. You can refer to the list of Target Maturity Funds or Passive Debt Funds in my earlier post “List of Debt Index Funds in India 2023“.



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