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