Fixed Deposit vs Bond

Bonds and Fixed Deposits (FDs) are the two most popular alternatives for risk-averse investors (investors who want to take a low risk). Both are popular among investors who fear volatility. While both bonds and FDs are 'fixed income' instruments, they differ across various parameters. It's worthwhile to educate yourself on the nuances of bond and fixed deposit investing to make an informed investment decision.

Fixed Deposit

Fixed deposits provide investment opportunities that banks and other institutions offer like NBFCs, Housing finance companies. In FDs, investors would deposit a lump sum over a period. In turn, they would get a fixed interest rate throughout the investment. The interest rate provided on FDs is very high than a savings bank account.

Characteristics of Fixed Deposits

The following are the critical characteristics of fixed deposits:

• Interest earned on FD varies from 5% to 7%.

• Senior citizens are provided with little higher returns (0.5% higher)

• The investment horizon of FDs ranges from a few days to years, and it differs among banks.

• Partial or complete withdrawals before maturity are permitted (with penalties)

• The return on investment in FDs is compounded periodically, say monthly or quarterly, or annually.

• Investors will accumulate higher returns if they invest for a more extended period.

• Once the investment matures, investors can reinvest for another term.

• Loans against FDs are available.

Tax saver FD

• One can invest in tax saver FD, up to 150000 per annum, and get a deduction under section 80C of 150000.

• The interest rate offered varies from 5.2% to 6.5% in some banks.

• Senior citizen gets additional 0.5% as interest.

• Interest earned is taxable.

• The amount of deposit made is deducted under section 80C.

• The deposit made is subject to lock-in for five years.

• No loan is offered against the tax saver FD.

Alternatively, one can invest in PPF, where the amount invested is eligible for deduction under 80C. And the interest earned on PPF is exempt. The tax-free interest offered on PPF is 7% to 8%. However, in PPF, there is a lock-in period of 15 years. And one can get a loan on PPF.

Taxation on FD

• Income earned on FDs (Interest) is taxed as per the slab rate. The interest of 50000 rupees for senior citizens is taxed first and allowed as a deduction under section 80TTB for senior citizens.

• As the FD interest is the taxable bank will deduct TDS on Interest earned. But if a person's income does not exceed the taxable slab, he can request the bank not to deduct the TDS by submitting form 15g in case of a senior citizen and form 15h for others.

Insurance on FD

The only risk with fixed deposit investments is the bank going bankrupt or defaulting. For such extreme situations, each depositor is insured up to a maximum of ₹5 lakh (for principal and interest). If you have multiple fixed deposits with more than one bank, the insurance coverage limit is applied individually to the deposits in each bank. Hence, it is advisable to deposit the amount in more than one account.

Biggest Disadvantage

It is said that money saved is money earned. But because of inflation, the value of money keeps decreasing. Presently inflation rate is around 8%. So the value of RS 100 today will be 92 rupees next year. So we need to earn a minimum of 8% on our investment to protect our capital. But in the case of FDs, we make an average of 6 percent, which is taxed at 30% assuming your income falls under the highest tax bracket. So after tax, you earn only 4.2 percent. Hence, FD is not a great avenue to park funds to preserve your money, so we need to look at its alternatives.

The best alternative for FD is investing in bonds, as they offer higher Interest and are less risky similar to FDs.

Bonds

A bond, in simple words, is a loan taken by a company from an investor. If it wants to borrow money, the company can go to the bank, but it borrows from the investor by issuing a bond. The company pays interest to consider the amount borrowed, calculated as a percentage of the face value. The interest is paid periodically (usually annually or semi-annually). The company repays the principal on the maturity date of the bond.

Why will a company borrow money from individuals/ corporate houses?

Banks will lend business loans to corporates at a high rate. Corporates issue bonds to investors to get a loan at cheaper rates. It is a win-win situation for the investor as well as the corporate. Since the corporate gets interests at a lower rate than an availing loan from a bank. And the investor receives a higher return than giving money to a bank in the form of FDs.

Elements of Bonds

• Interest or coupon rate

  It is the annual amount of interest that the bond owner will receive. Generally, Interest earned on bonds ranges from 8 to12 %.

  How to Calculate Coupon Rate?

  Suppose you purchase a bond with 1,000 Rs face value with semi-annual payments of 50 Rs each. A Bond's coupon rate is calculated by dividing the total annual interest by face value. Here, the total annual interest payment equals 50 x 2 = 100. The annual coupon rate for the bond is thus 100 / 1,000 or 10%.

• Tenure of bond

  In shares, there is no tenure. But in the case of bonds like FDs, there is a period after which the bond will mature. The bond term is the time between bond issuance and bond maturity.

• Market Value

  Like shares, bonds are traded in the market. Market value is the value at which the bond is currently being sold.

• Face value

  The price of a single unit of a bond issued by a company is face value. The price of bonds is often referred to as principal, nominal, or par value. Bonds can be given at par, discount, or premium.

• Redemption Value

  It is the value at which bondholders will receive their principal. The company may repay it at par, discount, or premium. The redemption is done on the redemption date, which is mentioned in the offer letter.

• Taxation

  There are two ways in which an investor can earn profit by investing in bonds: Interest and capital gain.

  Interest income earned by the investor is taxed as per the slab rate.

  Capital gain equals the difference between the sale price and the purchase price. Capital gain is classified into long-term capital gain and short-term capital gain.

  A long-term capital gain arises when the holding period is greater than 12 months and is taxed at the rate of 10% without indexation.

  Whereas the short-term capital gain is taxed as per the slab rate.

• Tax-free bonds

  There are certain popular bonds like NABARD, HUDCO, REC, and PFC which are tax-free. Wherein the interest is exempt as a result, the net interest earned is superior as it varies from 7% to 10% tax-free.

  The capital gain on these bonds is taxed, similar to other bonds.

Types of bonds

Corporate bonds: It is issued by the company. These bonds are received for a fixed period with a specified interest rate.

Convertible bonds: These bonds benefit both debt and equity to the shareholders but not simultaneously. Usually, investors will subscribe to bonds first, with the option to convert their bonds after a specified period. In return, shareholders will get a specified number of shares based on the conversion ratio.

Government bond: It is issued by the Central or State government. Government bonds can be subscribed to by small investors also. These bonds are one of the most secured bonds.

Zero-coupon bonds: Zero-coupon bonds are issued at a discount and later redeemed at face value. So the difference between the redemption value and the issue price will be the consideration for the investor as he will not get Interest every year.

Sovereign gold bond: This bond is an alternative to direct gold investment. Suppose a person is not interested in having a physical position of gold. He can buy sovereign gold bonds.

Advantages of investing in Sovereign gold bonds than physical gold

1. More returns and Fixed income: When a person buys physical gold, he must incur making charges. In Sovereign gold bonds, there are no making charges, and in addition, he gets 2.5% per annum interest on the bonds, which is over and above the gold returns he will get on SGB bonds. No risk of theft and insecurity of purity.

When a person invests in gold, he does not get any fixed income like how one gets in shares (dividend) or land (rent).

But in sovereign gold bonds and capital appreciation, which is similar to appreciation in the gold value, one also gets fixed income in the form of Interest, which is 2.5% per annum.

2. Tax-free: In physical gold capital gains are taxed. Whereas, in SGB bonds, the capital gain attributed to the appreciation in gold prices is not taxed. Only the interest income is taxed.

3. Sovereign guarantee: SGB bonds are backed by the government as they get a 100% sovereign guarantee from the government. At the same time, there is no guarantee of physical gold. For example, nobody will pay for it if you have bought physical gold and if it has impurities. One will have to take legal action. Physical gold carries the risk of theft.

Therefore, the sovereign gold bond has many advantages over physical bonds. Still, it has certain limitations, specifically that there is a lock-in period of 5 years, and it has less liquidity.

Conclusion

A famous saying is never put all your eggs in one basket. Most interpret that one should not invest all your money in one stock. But it means don't put all your money in one asset class. So, one should invest in an asset class with low risk, too and most people in India are aware of only FDs when investing in a low-risk asset. But they should not ignore bonds as they have risks almost similar to FDs, but they provide a better return than FDs.