In the realm of fixed-income securities, Bonds and Fixed Deposits (FDs) emerge as prominent players, each offering distinct advantages and limitations. However, despite Fixed Deposits being widely popular, Bonds remain relatively overlooked. A 2017 survey conducted by SEBI revealed that over 95% of Indian households favored Fixed Deposits (FDs) as their preferred investment option. On the other hand, only a mere 10% opted for mutual funds and stocks.
What are Bonds?
Bonds are essential in assisting businesses and government organisations to get funding for a variety of objectives, including maintaining operations, starting new projects, or completing acquisitions. A bond buyer is essentially making a short-term loan to the bond's issuer when they buy one. They receive consistent interest payments in exchange for the duration of the bond.
The investor is given their original loan amount back after the predetermined length of time has passed. A bond's interest rate may change or remain stable depending on the terms of the contract. Although they are often thought of as being less dangerous than stocks, bonds still carry some risk. Several elements, including inflation, creditworthiness, and interest rate changes, might have an impact on the bond's overall performance and that may influence the investor's returns.
Features and Benefits of Bonds
- Bonds typically offer slightly higher interest rates than FDs and pay interest quarterly, monthly, semi-annually, or annually.
- The bond's credit quality is a significant determinant of its interest rate, with lower-rated issuers offering higher interest rates due to increased default risk.
- Bondholders are given priority over stockholders in case of bankruptcy and liquidation.
- For issuers, bonds serve as a means to meet short, medium, and long-term capital requirements.
- Bonds provide better risk-adjusted returns, making them a stable and consistent investment option.
What are Fixed Deposits?
With fixed deposits, investors deposit a fixed amount for a predetermined amount of time in exchange for a fixed return. Banks, post offices, and non-banking financial institutions all provide FDs. They provide the flexibility of simple withdrawal along with a fixed rate of interest for a set period. However, early withdrawal may result in fees or lowered interest rates.
Learn more about FDs - Features of a Fixed Deposit Account.
Comparing Bonds and Fixed Deposits
| Parameters | Bonds | Fixed Deposits (FD) |
|---|---|---|
| Meaning | A bond is a financial instrument that signifies a loan from an investor to a borrower. In return, investors receive regular interest payments, and the principal amount is repaid upon maturity. | A fixed deposit (FD) is a type of investment where individuals deposit a specific amount of money with a bank, post office, or NBFC for a predetermined period, earning interest on it until maturity. Upon maturity, both the principal and interest are returned. |
| Issued By | Bonds can be issued by various entities such as government bodies, municipalities, states, or private companies. | Fixed deposits are offered by banks, post offices, and NBFCs (Non-Banking Financial Companies). |
| Safety | Bonds are generally considered safe investments since they are backed by physical assets. However, investors should also check the credit rating of the bond issuer to assess its financial stability. | Fixed deposits are also considered safe, but they do not have physical asset backing. It is crucial to select a reliable institution to open an FD for added security. |
| Liquidity | Bonds are more liquid assets because they can be traded on stock exchanges. However, their prices can be affected by changes in interest rates, leading to market volatility. | While fixed deposits are less liquid compared to bonds, investors can still opt for premature withdrawal. However, doing so may incur penalties or reduced interest rates. |
| Payout Frequency | Investors usually do not have control over the payout frequency of bond interest. It is typically disbursed half-yearly, yearly, or at maturity. | Fixed deposit investors have the flexibility to choose the payout frequency that suits them best. |
| Returns | Bonds have the potential to offer higher returns than FDs, especially after accounting for taxes. However, returns on bonds are subject to market fluctuations. | FDs provide a fixed return to investors throughout the investment period, offering more predictable returns. |
| Credit Rating | Bond issuers are required to obtain credit ratings from agencies like CARE, ICRA, or CRISIL to assess their creditworthiness. | While FDs issued by NBFCs must have mandatory credit ratings, those from banks and post offices may not necessarily require credit ratings. |
| Accessibility | Bonds may not be easily accessible for retail investors, as they are often purchased over the counter or through bond brokers. | Opening a fixed deposit account is relatively simple and accessible to investors, as it can be done with banks, post offices, or NBFCs. |
| Liquidation | In the unfortunate event of bankruptcy and liquidation, bondholders are prioritized and receive payments before other creditors. | Although FDs are not backed by physical assets, they are insured up to ₹500,000 by DICGC, providing a level of protection to investors' principal and interest amount. |
| Taxation | The taxation of bond returns depends on their holding period, and some government-issued bonds may offer tax-free interest income. | Fixed Deposit returns are subject to income tax based on the investor's applicable tax slab. TDS (Tax Deducted at Source) is deducted at 10% if the interest income exceeds ₹40,000 (₹50,000 for senior citizens). |
| 80C Deduction | Investing in bonds does not offer any special tax deduction under Section 80C of the Income Tax Act. | On the other hand, investing in tax-saving fixed deposits provides tax deductions of up to Rs.150,000 under Section 80C. |
Who Should Invest in Bonds?
Bonds are ideal for risk-averse investors seeking safety and assurance of principal and interest payment after a specific duration. Investors lacking stock market experience can use bonds as a long-term investment option, especially given the collateral backing that ensures payment on maturity. Although bonds carry some risk compared to FDs, investors should consider inflation risk and interest rate fluctuations that can impact their value over time. Bonds also offer a steady source of income and diversify investment portfolios.
Who Should Invest in FDs?
Investors who prioritize risk-free investment instruments should consider fixed deposits. These deposits offer predetermined returns and shield investors from market fluctuations. While market-linked instruments may offer higher returns, they entail higher market risks, necessitating a balanced approach with safer investment options like fixed deposits.
Bonds vs. FDs – Which is Better?
Both bonds and fixed deposits provide safe investment options, catering to various investment horizons. Investors can diversify their portfolio by selecting a mix of both instruments based on their goals and risk tolerance. Fixed deposits guarantee complete security and assured returns, making them easily accessible. Bonds, on the other hand, offer higher returns upon maturity, but their prices may fluctuate due to interest rate changes. Informed decisions should consider investment goals, horizon, and risk understanding.
Final Thoughts
In the world of fixed-income securities, bonds and fixed deposits present distinct investment opportunities. While fixed deposits offer security and predictable returns, bonds provide the potential for higher returns but carry some risks. Investors must carefully assess their preferences, goals, and risk tolerance to make an informed choice that aligns with their financial objectives.
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FAQs
1. Are bonds a secure form of investment?
Yes, generally, bonds are considered relatively secure, especially when compared to riskier investments like stocks or commodities. They often have collateral backing, providing a certain level of security.
2. Who issues bonds?
In India, bonds are primarily issued by Public Sector Undertakings, State Governments, Banks, Corporations, NBFCs (Non-Banking Financial Companies), Municipality Corporations, and the Central Government.
3. What is credit risk in bonds?
Credit risk, also known as default risk, refers to the possibility that a bond issuer may fail to make interest and/or principal payments. Government bonds are generally less likely to default, whereas corporate bonds carry a higher risk of default.
4. Is FD safer than bonds?
Both FDs and bonds are considered safe investments, but FDs lack physical assets as collateral. It’s essential to choose a reliable institution for opening an FD. Bonds, being traded on a stock exchange, are more liquid, but their prices can be influenced by interest rate movements.
