Introduction
When investing, many pursue stability and predictable returns, making Bonds and Fixed Deposits (FDs) popular choices. Both are relatively low-risk investments that provide steady income. However, they differ notably in terms of returns, liquidity and investment strategies. Bonds may offer predictable returns with varying risk profiles and liquidity, while FDs provide assured returns with fixed interest rates and limited liquidity. The detailed differences between Bonds and FDs are outlined below.
What are Bonds?
Bonds are debt
securities issued by governments or corporations to raise funds. When you buy a
bond, you are lending money to the issuer in return for periodic interest
payments and the repayment of the principal amount at maturity. Bonds can vary
in terms of duration, interest rates and risk profiles, depending on the
issuer’s creditworthiness and the bond’s specific features. This diversity
allows you to choose bonds that align with your risk tolerance and investment
goals.
Types of Bonds
Bonds are broadly categorized into the following types:
• Government Bonds: Issued by central or state governments, these bonds are considered relatively low-risk as they are backed by the government’s credit. Examples include Dated Government Securities (G-Secs), Treasury Bills (T-Bills), Cash Management Bills (CMBs) and State Development Loans (SDLs).
• Corporate Bonds: These bonds are issued by companies to raise capital for expansion or operations. Corporate bonds may offer attractive interest rates than government bonds but come with relatively higher risk.
• Convertible Bonds: These bonds can be converted into a specified number of shares of the issuing company, providing potential upside if the company’s stock performs well.
• Zero-Coupon Bonds: These bonds are sold at a discount and do not pay interest periodically. Instead, they mature at face value, with the difference representing your return.
Key Features of
Bonds
Bonds come with the following features:
• Interest Payments: Bonds provide regular income through interest payments, known as coupons. These payments are usually made either semi-annually or annually, offering you a predictable stream of income throughout the life of the bond.
• Maturity Date: This is the date when the bond reaches the end of its term, and the issuer is required to repay the principal amount to the bondholder.
• Credit Rating: Bonds are evaluated and rated based on the issuer’s creditworthiness. This rating indicates the bond’s risk level and potential returns, with higher ratings signifying lower risk and generally lower yields, while lower ratings suggest higher risk but potentially higher returns.
Advantages of
Bonds
With bond investments, you can benefit from the following:
• Predictable and Regular Income: Bonds offer a stable income stream through regular interest payments.
• Diversification: Investing in bonds allows for diversification beyond traditional assets like equities and real estate. By incorporating bonds into a portfolio, you can spread your risk across different types of investments, potentially reducing overall portfolio volatility.
• Safety: Government bonds, backed by the issuing government, are regarded as low-risk investments. This government backing provides a high level of safety, making it a secure option if you are a risk-averse investor seeking stable returns.
What are Fixed
Deposits?
Fixed Deposits (FDs) are savings instruments, where you deposit a lump sum for a fixed period at a predetermined interest rate. During this tenure, you earn interest, which can be received at regular intervals or upon the deposit’s maturity. FDs provide assured returns, offering a safe and predictable income stream. You can choose the tenure and interest payout frequency, making FDs a relatively secure and flexible option for conservative investment planning.
Types of Fixed
Deposits
You can park your funds in a wide range of FDs. Types of FDs include:
• Regular Fixed Deposits: These are standard Fixed Deposits you can open with a bank where you deposit a lump sum for a fixed tenure at a predetermined interest rate. The interest can be paid out periodically or at maturity. They offer stability and guaranteed returns, making them a popular choice for risk-averse investors.
• Tax-Saving Fixed Deposits: These FDs offer tax benefits under Section 80C of the Income Tax Act, 1961, allowing you to claim deductions up to ₹1.5 lakh per year. They come with a mandatory five-year lock-in period, and premature withdrawal is not allowed.
• Corporate Fixed Deposits: Corporate Fixed Deposits are term deposits offered by corporates. They may provide attractive interest rates than traditional bank FDs. These deposits have fixed tenures and interest payouts, with varying degrees of risk based on the company’s credit rating. It is essential to assess the company’s financial stability before investing.
• Senior Citizens’ Fixed Deposits: Designed specifically for individuals aged 60 and above, these FDs offer a competitive interest rate, typically more than regular FDs.
Key Features of
Fixed Deposit
Explained below are some common features associated with FDs:
• Interest Rate: The interest rate for Fixed Deposits is locked in for the entire tenure, ensuring predictable returns regardless of market fluctuations.
• Tenure: The deposit duration can range from a few months to several years, allowing you flexibility in choosing a term that suits your financial goals.
• Premature Withdrawal: Fixed Deposits offer the option for early withdrawal, though penalties may apply. While full withdrawals may incur charges, partial withdrawals are often allowed, providing some liquidity during emergencies.
Advantages of
Fixed Deposits
Here’s what makes FDs a popular choice:
• Assured Returns: Fixed Deposits offer a fixed interest rate throughout the tenure. This makes FDs a reliable investment option for those seeking stability and predictability in their income.
• Safety: FDs are considered low-risk investments. They are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC) for amounts up to ₹5 lakh, providing added security.
• Liquidity: While Fixed Deposits are generally meant to be held until maturity, they offer the flexibility of premature withdrawal. However, early withdrawals often incur penalties, although they allow for access to funds in emergencies.
Bonds vs Fixed
Deposits
Bonds and FDs share numerous similarities when it comes to predictable returns, investment horizon and investor’s risk appetite. The following are the differentiating factors:
• Returns
The interest earned on bonds typically varies based on the type and issuer. Corporate bonds often offer relatively higher returns but come with higher risk, whereas government bonds provide lower returns but are considered safer due to government backing. Bonds may also offer inflation protection and capital gains if sold before maturity.
Fixed deposits provide fixed interest rates for a specified tenure, ensuring predictable returns. However, FD rates are generally lower than bond yields, especially during low-interest periods.
• Risk
Bonds carry varying levels of risk, largely depending on the issuer’s creditworthiness. Government bonds are considered the safest due to government backing, making them a relatively low-risk investment. Corporate bonds, on the other hand, carry relatively higher risks, particularly if issued by companies with lower credit ratings. Fixed Deposits are generally low-risk, but they still face risks like inflation. Consider FDs from reputable financial institutions with DICGC insurance coverage and diversify investments across various tenures and institutions.
• Liquidity
Bonds offer relatively better liquidity as they can be sold in the secondary market before their maturity date. However, the price at which bonds are sold can vary based on market conditions, potentially resulting in a capital gain or loss. Liquidity in bonds depends on the type of bond and market demand, making it a flexible yet uncertain option.
Fixed Deposits offer liquidity through premature withdrawal, but this usually comes with penalties. While you can access funds in emergencies, the penalised returns make FDs less liquid compared to bonds.
• Taxation
Interest income earned from bonds is taxable according to your income tax slab. However, certain bonds, such as tax-free bonds and capital gain or 54EC bonds may offer tax benefits.
The interest earned on Fixed Deposits (FDs) is fully taxable according to your income tax slab rates. While tax-saving FDs offer benefits under Section 80C of the Income Tax Act, allowing deductions of up to ₹1.5 lakh per annum, the interest income from these deposits remains taxable.
• Flexibility
Bonds offer considerable flexibility with a wide range of options in terms of types, durations, and risk levels. Convertible bonds, for example, provide you with the opportunity to convert bonds into equity shares, adding a potential upside. Additionally, inflation-indexed bonds and zero-coupon bonds allow for varied strategies based on your goals. Fixed Deposits have fixed terms and interest rates, with limited flexibility.
• Holding
In bonds, the holding can be in two forms: physical certificates or dematerialized (demat) format. Demat holding is more common, offering easy transfer, sale, and tracking. Bonds can also be traded in the secondary market, allowing flexibility in ownership.
Fixed deposits are usually held with the issuing bank. Ownership is simpler, as FDs do not involve trading. They are locked for a fixed tenure, with the investor receiving interest payouts at regular intervals or upon maturity, depending on the chosen option.
• Credit Rating
Bonds are typically rated by credit rating agencies, with ratings indicating the issuer’s creditworthiness. The ratings are based on the financial strength of the issuing company.
Most bank FDs are not rated by credit rating agencies since they are considered secure by virtue of being offered by regulated banks. Deposits up to ₹5 lakh are insured by the DICGC. Corporate FDs, on the other hand, come with credit ratings assigned by agencies. Typically, a higher credit rating indicates better financial health of the company.
Credit rating is a crucial factor in bonds as it directly influences the risk and return. Generally, lower-rated bonds may offer relatively higher yields but come with a greater risk of default.
• Issuer
FDs are generally issued by banks or non-banking financial companies (NBFCs). Bank FDs are widely popular as they are regulated by the RBI. Some corporates also offer FDs. The risk of corporate FDs depends on the issuer's credit standing.
Bonds can be issued by the central or state governments. Government bonds, also known as G-Secs, are considered one of the safest investment options. Corporate bonds are issued by private companies to raise funds. Bonds may also be issued by municipal bodies or public sector units for infrastructure development projects.
• Investment Process
FDs are straightforward and easy to invest in. You can use online banking platforms to open an FD account with your bank.
Bonds can be purchased through stock exchanges, brokerage firms, or online bond platform providers (OBPPs). Altifi, an OBPP, allows you to invest in bonds seamlessly.
Bond Vs Fixed Deposit: Which One Should You Choose?
The decision to invest in bonds, fixed deposits or both ultimately depends on your financial goals and risk tolerance. Bonds typically offer steady returns with varying levels of risk. Fixed deposits, on the other hand, provide assured returns. Both options have their merits: Bonds and FDs both can help diversify your portfolio. Consider your income needs and financial priorities to choose the one that best aligns with your goals.
Invest In Bonds
Through Altifi
Both bonds and fixed deposits appeal to conservative investors seeking safety and stable income. Investing through Altifi provides access to a wide range of bonds, along with tools for performance tracking and a user-friendly interface, enhancing your investment experience.
*Disclaimer: The contents of this article should not be construed as tax or financial advice. Readers should seek advice from their tax or financial advisor before making any investment decision.
References:
https://www.rbi.org.in/commonperson/English/Scripts/FAQs.aspx?Id=711
https://www.rbi.org.in/commonman/english/Scripts/FAQs.aspx?Id=272