If you are a risk-averse investor, you must have heard of gilt funds. It is a popular type of debt mutual fund. They are known to generate higher returns than a normal FD, so they are popular among investors. Today, let’s explore more about gilt mutual funds or gilt funds.
What Are Gilt Funds?
Gilt funds are nothing but a popular type of debt fund. Here, the accumulated capital of investors is invested in securities issued by the central and state governments; hence, they are said to be a safe investment option for investors. As per SEBI guidelines, the fund house must invest 80% of its corpus in government securities.
As the government backs the securities where the money is invested, they are known to be highly safe.
Working of Gilt Funds
Whenever the central government or the state government is in need of funds, they go to the RBI for money. As we know, RBI is the banker to the government; it issues gilt funds with a maturity date and a said interest rate. As the ticket size of this investment is huge, a normal retail investor cannot afford to invest in it. However, a fund house accumulating capital from several investors can afford to purchase these gilt securities on its investors’ behalf, and the interest earned is further distributed to the investors.
Interest Rates and Gilt Funds
Let’s break it down with a simple example. Imagine there are two gilt funds, X and Y. Fund X gives you an 8% return when the interest rate is 7%. A year later, the interest rate drops to 6%, and now fund Y offers a 7% return.
Which one would you choose to invest in? Most likely, you would go for fund X because it gives you 1% more profit compared to fund Y. So, a lot of people will want to invest in fund X, and its price will go up. As a result, the profit it offers will decrease.
Similarly, when the central bank (like the RBI) raises interest rates, fewer people want to invest in funds with low-interest rates. When these funds become less popular, and their prices drop, the profit they offer goes up.
That’s an interesting concept, isn’t it?
Things to Note Before Investing in a Gilt Fund
Before investing, always check the yield to maturity. It tells you the returns the fund will generate if you invest in it and hold it till maturity.
While investing, check the average maturity of gilt funds and match it with the duration of your goals.
Next, you must check the modified duration. It tells you how volatile the bond would be. The bond will experience frequent interest rate fluctuations if the modified duration is high.
Taxation of Gilt Funds
- As gilt funds invest in bonds issued by the government, it attracts taxation similar to debt instruments.
- If you sell your units within three years, a short-term capital gain tax will be applicable at 15%.
- If you sell your units after three years, a long-term capital gain tax will be levied at 20% with indexation benefits.
To conclude, gilt funds are the ideal investment for risk-averse investors and those who are looking for an alternative to fixed deposits.
That’s it for today. We hope you’ve found this article informative. Remember to spread the word among your friends. Until we meet again, stay curious!
*The article is for information purposes only. This is not an investment advice.
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