Bonds


Held exclusively by Banks, Corporates, HNIs and other large financial institutions up until now, we’ve opened up the fixed income investment market to individual investors like you

Why Invest in Bonds

As soon as one starts earning, you would have heard elder family members saying that a good portion of your portfolio must be invested in FDs for Safety and Liquidity. A sign that the individual is capable of managing his finances and can save for long-term goals. While they are right about investing a portion of your portfolio into Riskless Liquid Investments- FDs might not be your best bet today.

During the 90s, the FD rates were around 13%. Hence FDs were lucrative. But since then we’ve seen a steady fall, and the current FD rates have plateaued to approximately 5.6% (for a duration between 1 year to 10 years).

Apart from failing interests, there are some other problems with FDs as well:

    1. Contrary to popular belief, FDs are not Risk-Less.

      Under the Deposit Insurance and Credit Guarantee Scheme of India, only fixed deposits up to 1 lakh (Proposed by FM to be increased to 5 Lakh) are insured. So, in case of an unforeseen circumstance, you will only receive this amount back, and not your complete invested amount with interest. So, while banks have made it easy to open online fixed deposits and have multiple fixed deposit accounts, little has been down to safeguard your investment. And you’ve seen what went happened with PMC Bank, Yes Bank, Sri Gururaghavendra Sahakara Bank Niyamitha Bank in Bengaluru. All things pointing in one direction -> FDs are not Risk-Less.

    2. FD renewals and pre-mature withdrawals are both detrimental

      One of the primary reasons why we keep some of our money in FDs is that they can be broken/money can be withdrawn whenever required. However, most banks have pre-closure charges for breaking a fixed deposit before it matures and don’t offer the same interest rate if the deposit is not held for the full term. This means that your investment has actually lost money. The same holds true for renewals as well. It’s customary for individuals to renew fixed deposits without analysing the profits made during the initial tenure. Moreover, with the reducing FD rates, it’s likely that you’re reinvesting your money for lower returns than before.

    3. In the long run Inflation rates beat Interest rates

      Inflation rates in India are at an average of 5%, and the current rate of interest on fixed deposits post-tax (assuming taxation rate of 25%) is less than 4.5% and hence earnings from fixed deposits after deducting tax cannot beat inflation in the long-run. Further, major expenses of the future like health, education, real-estate investments, will only be higher than present-day rates. So, Investors need to carefully assess these factors and invest in appropriate asset classes to be able to beat inflation.

So, I understand but I want a Fixed Income and I don’t like Life Insurance Policies because of their complexities and Terms & Conditions, so where should I invest?

Advantages of Bonds

Today, it is better to invest in Bonds rather than FDs. Let me tell you why:

  1. Bonds are Stable Fixed Income Securities

    Bonds are predictable. You know how much interest you can expect to receive, how often you'll receive it, and when your principal (the bond's face value) will be repaid (maturity date).Bonds are steadier than stocks (which can fluctuate wildly short-term). Nervous investors usually sleep better by buying bonds instead of equity investments.

  2. Bond Interest rates are higher

    FD rates are lower than bond interest rates. Banks have to maintain CRR (Cash Reserve Ratio) as per regulations laid down by the central bank. The banks must reserve a portion of capital received via FDs; entire capital cannot be lent out. This reserved capital can be utilized to supply closures (or pre-closures) in FD. Such constraints are not there on banks on the capital that is raised via bonds. Hence bond rates are higher than FD rates.Bonds are tradable; hence you can sell when interest rates increase, resulting in capital gain. FDs are not tradable, and they come with fixed lock-in. The investor has to pay the penalty on premature closure of FD. Both FD and bonds fall into the category of low-risk securities.

  3. Bonds may provide Tax Advantages

    While the income on FDs & interest on bonds are both taxable at your slab rates, with bonds the difference is that if one sells the bond after a holding period of 1/3 years(Depending upon whether the bond is listed or unlisted) but before maturity, at a premium then he/she may enjoy a tax advantage since the gains will be taxed as long term capital gains @ 10%/30% (Depending upon whether the bond is listed or unlisted).

Risks in Bond Investment

Bonds are considered a safe haven, but bonds do come with a couple of risks. So, now let’s talk about them.

The term “Risk in Bond Investment’’ sounds like an oxymoron. Because once we hear the word “Bonds”, what comes to our mind is: bonds are debt investments, they give fixed returns and are safe. Nevertheless, bonds do come with a couple of risks. Let’s get aware of them and learn a few simple strategies on how to mitigate them. If you are not sure of terminologies used in the Bond market you may refer our blog here - ‘The ABC of Bonds’.

In the bond market, risk of not getting interest payments/principal amount back on your investment is termed as “Credit Risk” 

Credit Risk:

One of the key risks of investing in Bonds is the risk of facing non-payment of interest or principal or both by the Bond issuer. This loss to the bond buyer is called the credit risk. It can happen if the bond issuer runs into financial trouble and is incapable of paying. Hence, while picking up bonds, it is especially important to invest in entities that have sound financial performance. 

Resolution for credit risk: Go for “AAA” rated bonds, these bonds are less risky than other lower-rated bonds. 

Interest Rate Risk:

First and foremost, please note: Bond prices and interest rates are inversely proportional.

Interest Rate Risk is the risk of getting a lower sell price than the price at which the bondholder bought the bonds in the first place. Different factors influence Interest Rates i.e. Monetary Policy, Inflation, and the strength of the economy. If interest rates increase the price of the bond decreases. At this time if the investor wants to sell the bonds, he/she has to sell at a discount price. 

However, the flip side is that, if the interest rates in the economy decrease, the selling price of bonds will increase. At such a time, an investor can make capital gains by selling his bonds at a premium to his buy price.

Example: 

Let’s assume you are holding bonds issued by XYZ company at a purchase price of 100. At this time, the interest rates in the market are 7%.

Case 1: Now if interest rates increase to 8 %, bond price will fall in the market, to say 99. Then if you sell the bonds, you will lose ₹ 1 per bond.

Case 2: If the interest rate falls to 6%, then the bond price can increase to, say ₹ 101. Then if you sell the bonds, you will earn capital gains of ₹ 1 per bond. 

Liquidity Risk:

Liquidity is the ease of selling off a bond in the market and getting cash in return. This risk of monetary loss due to a smaller number of buyers/ low demand for a given security is termed as Liquidity Risk. 

Note: Liquidity risk arises only when you want to sell off the bond before it matures. Factors that influence liquidity risk are:

  • Demand 
  • Market Price 
  • Associated Risk 
  • Lack of information 

One major factor that triggers liquidity risk is ‘Lack of information’ on the demand side. When a seller is unaware of the number of buyers looking to buy bonds, we can say he is unaware of demand and may develop a misconception of low demand.  He then agrees to sell the bonds at a discount price.

Way out: Innovation in technology can mitigate this liquidity risk. For Listed Bonds one can check the last traded price by searching the ISIN of the bond over BSE/NSE’s Website and for unlisted bonds, websites like ours can connect buyers and sellers.

So, I want to invest in a bond instrument.

I don’t like the low interest rates of FDs.

But I don’t want to take unnecessary risk.

What should I do?

Buy a Bond and use the Hold to Maturity Strategy (HTM). If you plan to hold bonds till maturity, Liquidity risk and Interest rate risk will not come into picture. Liquidity risk can be handled efficiently with the help of the latest connective technological innovations and players like we ourselves. So here, if you hold the bonds till maturity the only risk you take is Credit Risk i.e. If the issuer is financially sound and makes payments on time, you will get your money back on maturity.

Upgrade to fixed income investments with Richfield Fintech. Held exclusively by Banks, Corporates, HNIs and other large financial institutions up until now, we’ve opened up the fixed income investment market to individual investors like you.

Bonds - Taxation

TYPE OF SECURITY HOLDING PERIOD TO QUALIFY AS A LONG-TERM ASSET TAXABILITY OF SHORT-TERM CAPITAL GAINS TAXABILITY OF LONG-TERM CAPITAL GAINS
Listed debentures and bonds * More than 12 months Gains shall be taxed as per normal slab rates Gains shall be taxed @ 10% without indexation
Unlisted debentures and bonds * More than 36 months Gains shall be taxed as per normal slab rates Gains shall be taxed @ 20% with indexation

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