Investing in Government Bonds – Advantages and Disadvantages

Even though government bonds have been made available to retail investors, allocating money without considering the pros and cons can be counterproductive. Government bonds carry lower risk compared to other assets like equities, as the returns are guaranteed by the government. There are some market-related risks, but by simply holding on to the bonds until maturity, you can nullify the risk. The government pays a fixed interest rate on the bonds and by remaining invested in government bonds until maturity, you can derive maximum yield. One can also consider investing in government bonds to diversify his/her portfolio as these are largely stable and perform well when other asset classes are under pressure.

There are several advantages of government bonds, but investing in government bonds also has some drawbacks. In theory, government bonds offer adequate liquidity as the demand from large financial institutions is high. But financial institutions buy in large quantities and it is not possible for a retail investor to sell his/her bonds to banks and insurance companies. The secondary market for government bonds is not fully developed, which reduces the liquidity of government bonds. However, if you invest with a long investment horizon, liquidity will cease to be an issue.

While you can choose to directly invest in government bonds, it requires deep research and active participation, just like equity investments. An easier and more efficient medium to invest in government bonds is through bond exchange-traded funds. Bond ETFs can be an excellent proxy to invest in bonds issued by the government, corporations or public sector enterprises. Unlike government bonds, bond ETFs can be easily traded on the exchanges providing much-needed liquidity to the investor. Bond ETFs mirror debt indices which increase the level of diversification and simultaneously reduces the risk. You can also invest smaller amounts in bond ETFs. One has to invest a minimum of Rs 10,000 in government bonds directly but can buy a unit of bond ETF for as low as Rs 1,000. If you have a long-term investment horizon and need a transparent invest option with moderate risk, bond ETFs are the ideal medium to invest in government bonds. 

Should you consider investing in government bonds?

Now that you know the advantages of government bonds and have an idea about government bond funds, let us see whether investing in government bonds is suitable for you. You should consider government bond funds if you are keen on income generation because advantages of government bonds include the possibility of a stable and regular income stream. These funds primarily invest in government-issued bonds, which typically offer fixed interest payments at regular intervals. Government bond funds are also known for their capital preservation aspect as these are relatively safer than other fixed-income securities due to the backing of the government. These funds offer a lower level of risk compared to equities or corporate bond funds, making them suitable for conservative investors.

You can also choose this asset class for diversification as it helps you reduce the overall portfolio risk given its low correlation with equities. Further, such schemes can be attractive when interest rates are expected to decline or remain low. In such scenarios, bond prices tend to rise, leading to capital appreciation for investors. Finally, government bond schemes are a great option if you wish to enjoy optimal liquidity and accessibility as you can buy or sell their units on any business day.