Securities issued by the Govt. are normally considered to be risk-free. As they are backed by Govt. guarantee, it is quite logical to presume Govt. Securities (or Gilts as they are normally called) as the safest of all investments. Unlike a private company, Govt. is not going to default on its commitment to pay interest in a timely manner and return the principal on maturity.
This is perfectly correct...but this is not the complete picture.
Sure the "Default" risk in Gilts is, practically speaking, Zero...but default risk is not the only risk in Gilts.
One more significant risk in Gilts (or other debt instruments such as bonds, debentures, etc.) is the "Interest Rate" risk. Interest-rate risk is the risk of change in Gilt prices (or bond prices) with the movement in the interest rates.
There is an inverse relation between the two. When interest rates rise, the Gilt prices fall. Similarly, when interest rate falls, Gilt prices rise. In other words, like shares the price of Gilts also fluctuate. Of course, this movement is not as severe as in equities. But still it is quite significant.
As such, if your timing is right (i.e. you invest when the interest rates are at the peak) you can make good money by way of capital appreciation when the interest rates decline. For example, since RBI paused the rate hikes last year and began reducing the rates, Gilt funds have yielded around 12-15% returns.
However, if you get your timing wrong and interest rates start increasing after you invest in Gilts/Gilt funds, you will find Gilt prices falling. Thus you will experience a depreciation in your investment value. This fall be large enough to beat even the higher interest earnings and on overall basis you will lose money.
In short, be careful with your Gilt investments. You can lose money in Gilts too.
NOTE : Of course, this risk is applicable only if you do not hold the Gilt till the maturity date and instead sell it in the market before that. Also, given that direct investment in Gilt is not easy for a retail investor, most investors use the Mutual Fund route to take exposure to Gilts. And since MFs are open-ended with no specific maturity, Gilt MFs too are open to interest rate risk.
This is perfectly correct...but this is not the complete picture.
Sure the "Default" risk in Gilts is, practically speaking, Zero...but default risk is not the only risk in Gilts.
One more significant risk in Gilts (or other debt instruments such as bonds, debentures, etc.) is the "Interest Rate" risk. Interest-rate risk is the risk of change in Gilt prices (or bond prices) with the movement in the interest rates.
There is an inverse relation between the two. When interest rates rise, the Gilt prices fall. Similarly, when interest rate falls, Gilt prices rise. In other words, like shares the price of Gilts also fluctuate. Of course, this movement is not as severe as in equities. But still it is quite significant.
As such, if your timing is right (i.e. you invest when the interest rates are at the peak) you can make good money by way of capital appreciation when the interest rates decline. For example, since RBI paused the rate hikes last year and began reducing the rates, Gilt funds have yielded around 12-15% returns.
However, if you get your timing wrong and interest rates start increasing after you invest in Gilts/Gilt funds, you will find Gilt prices falling. Thus you will experience a depreciation in your investment value. This fall be large enough to beat even the higher interest earnings and on overall basis you will lose money.
In short, be careful with your Gilt investments. You can lose money in Gilts too.
NOTE : Of course, this risk is applicable only if you do not hold the Gilt till the maturity date and instead sell it in the market before that. Also, given that direct investment in Gilt is not easy for a retail investor, most investors use the Mutual Fund route to take exposure to Gilts. And since MFs are open-ended with no specific maturity, Gilt MFs too are open to interest rate risk.
