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Gilt Funds - Everything to know about them

Gilt funds invest in central government and state governments ' fixed-interest bonds. This money goes to building infrastructure and another government spending.

What are Gilt Funds

Gilt funds are a form of mutual fund that invests only in government-issued bonds and securities (g-secs). They vary in maturity and are considered a risk-free investment as the money invested is in the government's safe hands. Medium and long-term government securities are chosen for investment, and since the Reserve Bank of India (RBI) decides the interest on the same, it is considered an option for low-risk investment.

How do Gilt Funds work

When the Indian government needs funds (or loans), it approaches RBI. Besides being the central lender, the RBI also serves the government as the banker. Therefore, after borrowing from other institutions such as insurance companies and banks, the RBI loans money to the government.

In exchange for the loan, the RBI issues fixed-term government securities that are subscribed to by a gilt fund manager. This gilt fund returns securities from the government upon maturity and receives money in return. Gilt funds can be a perfect combination of low risk and fair returns for an investor. The efficiency, however, is highly dependent on interest rate movement. Therefore, the perfect time to invest in Gilt Funds would be a declining interest rate regime.

Taxation on Gilt Funds

There is no securities transaction tax (STT) that applies to the gilt funds. They are taxed as any other capital gain by investing in debt instruments under the Income Tax Act, 1961. If the investment duration is less than 1 year, your salary will be added to the short term capital gains and taxed according to your income slab. If for more than 3 years, the long term capital gains will be taxed at 20 percent with indexation.

Returns on Gilt Funds

The gilt fund carries a return based on the RBI fixed repo rate. If RBI does not adjust the interest rate, investing in Gilt Funds will be a good time. The funds offer fair and predictable returns, making it a preferred choice for many to invest.

Gilt funds are capable of yielding up to 12 percent. However, with changes in overall interest rates, returns from Gilt Funds are not guaranteed and highly variable. Therefore, investing in Gilt funds would be advantageous if interest rates fall. Gilt funds are still expected to deliver higher returns than even equity funds when the economy as a whole is facing a recession.

Risk on Gilt Funds

Gilt funds are the most liquid investments, as they do not bear credit risk, unlike corporate bond funds. The reasoning is that the government is never going to fail to meet its obligations. Gilt funds, however, suffer mainly from interest rate risk. In an increasing interest rate regime, the fund's net asset value (NAV) drops sharply, and this occurs because it leads to a rise in the fund's underlying asset prices.

Last Words

Investors need to assess their risk appetite before investing and then make an investment decision. The gilt funds are suitable for high security and reasonable return. A gilt fund maturity is lower than other types of mutual funds. The tenure depends on the bond in which you invest. Don't invest in the funds solely because of government security. Make rational decisions and invest only if it fits your investment requirements and helps you reach your financial goals in the long term. Learn about market sentiments and current interest rates before you make your decision and select a fund that has performed well in the x past.

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