When it comes to secure investment options in India, bonds and fixed deposits (FDs) often top the list. Both offer some security and predictable returns, but they have distinct features that may make one more suitable than the other depending on an investor’s financial goals and risk tolerance. This blog will delve into the differences between bonds and FDs, helping you make an informed decision that aligns with your investment strategy.
What are bonds and fixed deposits?
- Bonds: Bonds are debt securities issued by entities such as corporations, municipalities, or governments to raise capital. Investors who purchase bonds lend money to the issuer in exchange for periodic interest payments and the return of the principal amount periodically or at maturity.
- Fixed Deposits: Fixed deposits, commonly known as FDs, are investment products offered by banks and financial institutions. Investors deposit a lump sum of money for a fixed tenure and earn interest on it. The principal amount is returned along with the interest earned at the end of the tenure.
Q: How do bonds and FDs work in India?
A:
- Bonds: When you invest in a bond, you receive regular interest payments (coupon) until the bond matures. Upon maturity, the issuer repays the principal amount. Bonds can be traded in the secondary market if there is an interested buyer, allowing for potential capital gains if sold at a higher price than the purchase price.
- FDs: In an FD, you deposit a certain amount with a bank or financial institution for a predetermined period, ranging from a few months to several years. The interest rate is fixed at the time of investment, and you receive the principal along with the accrued interest at maturity.
Q: What are the types of bonds and FDs available in India?
A:
- Types of Bonds:
- Government Bonds: Issued by the central or state governments, these are considered the safest.
- Corporate Bonds: Issued by companies to raise capital, these offer higher returns but come with higher risk.
- Municipal Bonds: Issued by local government bodies, these fund public projects.
- Tax-free Bonds: Issued by government-backed entities, these provide tax-exempt interest income.
- Types of FDs:
- Bank FDs: Offered by commercial banks with varying tenures and interest rates.
- Company FDs: Offered by Non-Banking Financial Companies (NBFCs), usually offering higher interest rates than bank FDs.
- Tax-saving FDs: These have a lock-in period of 5 years and provide tax benefits under Section 80C of the Income Tax Act.
Q: What are the benefits of investing in bonds and FDs in India?
A:
- Benefits of Bonds:
- Higher Interest Rates: Bonds, particularly corporate bonds, often provide higher interest rates compared to FDs.
- Security: Majority of the bonds are secured by underlying collateral. However, there are bonds that are unsecured as well.
- Regular Income: Bonds provide regular interest payments, which can be a steady income source.
- Diversification: Adding bonds to an investment portfolio can reduce overall risk.
- Tax-benefits: Certain bonds, like tax-free bonds, provide tax-exempt interest income. Tax free bonds include bonds issued by government-backed entities such as the Indian Railways Finance Corporation (IRFC), National Highways Authority of India (NHAI), and Power Finance Corporation (PFC). The interest earned on these bonds is exempt from income tax under Section 10(15) of the Income Tax Act.
- Benefits of FDs:
- Safety: FDs are considered very safe, especially those with reputed banks, as they are insured up to ₹5 lakh by the Deposit Insurance and Credit Guarantee Corporation (DICGC).
- Fixed Returns: FDs offer fixed returns although lower than bonds, making them predictable and secure.
- Flexibility: Various tenures are available to suit different investment needs.
- Tax Benefits: Tax-saving FDs provide benefits under Section 80C.
Q: How are bonds and FDs taxed in India?
A:
Taxation of Bonds:
- Interest Income: Interest income from most bonds is taxable as per the investor’s income tax slab. This means that if you are in a higher tax bracket, you will pay more tax on the interest earned.
- Tax-free Bonds: Some bonds, such as those issued by government-backed entities like Indian Railways Finance Corporation (IRFC) and National Highways Authority of India (NHAI), offer tax-free interest income. This interest is exempt from income tax under Section 10(15) of the Income Tax Act.
- Capital Gains: If you sell bonds before maturity, any capital gains are subject to tax. Long-term capital gains (for listed bonds held for more than 12 months) are taxed at 12.5% without indexation benefits. Short-term capital gains (for listed bonds held for 12 months or less) are taxed at 20%.
Taxation of FDs:
- Interest Income: Interest earned on fixed deposits (FDs) is fully taxable and is added to the investor’s total income for the year. This income is taxed according to the investor’s income tax slab. For instance, if you fall into the 30% tax bracket, the interest earned on your FD will be taxed at 30%.
- Tax Deducted at Source (TDS): Banks and financial institutions deduct TDS at a rate of 10% if the interest income on FDs exceeds ₹40,000 in a financial year (₹50,000 for senior citizens). If you do not provide your PAN, TDS is deducted at 20%.
- Tax-saving FDs: These FDs offer tax deductions under Section 80C of the Income Tax Act, up to ₹1.5 lakh. However, the interest earned on these FDs is still taxable and added to the investor’s income.
Q: How can investors choose between bonds and FDs in India?
A:
- Risk Tolerance: Investors with slightly higher risk tolerance may prefer bonds for potentially higher returns, while conservative investors might opt for FDs for assured returns and safety.
- Investment Horizon: Bonds may be suitable for medium to long-term investments, while FDs offer flexibility with various tenures.
- Income Needs: Bonds providing regular interest payments can be beneficial for those seeking steady income, whereas FDs can be chosen based on liquidity needs.
- Tax Considerations: Investors in higher tax brackets may prefer tax-free bonds or tax-saving FDs to optimize their tax liability.
- Diversification: Investors should look to have both bonds and FDs as part of their balanced and diversified investment portfolio. FDs are great investment instruments for short terms needs while bonds are great for short and medium-term needs. Investors can choose to invest in bonds based on their risk appetite and choose a bond based on the credit rating, yield, tenure and returns.
FAQs
Q: Can NRIs invest in bonds and FDs in India?
A: Yes, NRIs can invest in both bonds and FDs in India, subject to certain regulations and documentation requirements. NRIs can invest in bonds through NRO or NRE accounts and can also invest in FDs offered by banks and NBFCs.
Q: Are bonds and FDs equally safe?
A: Generally, FDs are considered safer, especially those with reputed banks, due to insurance coverage up to ₹5 lakh by DICGC. Bonds, particularly corporate bonds, carry higher credit risk, though government bonds are relatively very safe.
Q: Can I break my FD before maturity?
A: Yes, you can break your FD before maturity, but it may attract a penalty, and the interest earned may be lower than the original promised rate.
Q: Do bonds offer better returns than FDs?
A: Typically, bonds, especially corporate bonds, offer higher returns compared to FDs. However, the risk associated with bonds is also higher compared to FDs.
