When it comes to choosing between various fixed income options such as Bonda, FDs, PPF and Bond -ETF, it becomes very confusing.
After saving some amount of hard-earned money, when it comes to investing, people usually go for fixed deposits due to the norm.
But a fixed deposit is a safe and secure investment plan but not always a successful choice. We will explore in this writeup some other popular fixed income schemes.
Fixed Deposit Investments
The Fixed Deposit is historically the most common investment choice among investors. Banks and non-banking financial entities that return fixed interests are selling these instruments. During the late 80s and early 90s, investors would avail the best FD rates from banks and other institutions.
In the late 80s, the rates were around 10%, and during the early 90s, it was about 13 percent. So during this period, FDs seemed a very lucrative option. Unfortunately, the current FD rate (for a tenure of five years to ten years) is around 4 – 5% with a few exceptions.
FD yields are usually smaller than other fixed-income options (Like bonds). As per the regulations laid down by the Reserve Bank of India, banks shall maintain the Cash Reserve Ratio (CRR). A part of capital obtained by FDs must be reserved by the banks and is used for the provision of FD closures or pre-closures. Banks cannot lend the full money.
Cash obtained through fixed deposits doesn’t reach investors as the money is locked until maturity. The investors do not receive real cash flow from FDs. For FD, the successful returns are much smaller than a specific system that pays out yearly. The investors must pay the penalty for premature closure of the FD.
Benefits
- For PSU banks, the risk associated with FDs is as low as zero.
- FD tenure extends from 7 days to 10 years, and the term may be selected by the investor to fit his or her requirements.
- The investor may take a loan against FDs; banks usually offer loans up to 60-90 percent of the deposit value.
Drawbacks
- In the case of FDs, the interest rate is very low, and that results in a lower return if an investor opts for regular payouts or premature withdrawals.
- Investors can’t trade FDs. Once an investor takes the tenure option, he/she must adhere to that.
- TDS and capital gain tax are applicable on the interest revenues from FDs.
Public Provident Fund
The Central Government proposes the PPF as a saving scheme. The interest rate is about 7.10 percent, and the duration of lock-in is 15 years, and premature withdrawals are subject to penalty. The capital gains from PPF at maturity are not taxable. PPFs are not linked to the market and are thus free from market fluctuations and are not tradable either. The maximum deposit allowed every year is ₹ 1.5 lakhs.
Benefits
- The interest rate is marginally higher than FDs.
- The investor is allowed to take out a loan against his PPF investment after completing three years.
- PPFs are risk-free as the central government backs them.
- 100% tax exemption for the earnings from the interest and returns at maturity.
Drawbacks
- It is a long-term commitment, and specific provisions result in loss of returns if there are early withdrawals.
- If an investor plans to spend more than ₹ 1.5 lakhs in the same year, he/she can’t opt for PPF.
Bond Exchange -Traded Funds
A collection of underlying debt securities such as corporate bonds or sovereign bonds are composed of bond ETFs. ETFs, traded on NAVs and highly liquid, are listed on all major stock exchanges. ETFs are an alternative for multiple bond purchases at a time. Such ETFs offer monthly interest payouts, but with underlying bonds, the value of coupons varies. There is no fixed maturity with ETFs. Interest gained is subject to TDS and capital gain tax.
Benefits
- Bond ETFs offer an investor’s bond investment portfolio immediate diversification.
- Bond ETFs are, in essence, highly liquid. They can be quickly sold off on the exchange.
Drawbacks
- There is no maturity date for bond ETFs, so an investor will have to sell an ETF bond to get the principal back. This suggests that the consumer needs to keep a constant watch on the ETF’s price volatility.
- When compared to underlying bonds, the rate of interest is lower.
- Investors are not allowed to borrow against the Bond-ETFs.
- Monthly coupon payments are secured, but the coupon value is not fixed. This fluctuation will influence the financial plan of the investor.
- A case of exception: The working of the Bharath Bond ETF is very distinct from regular Bond ETFs. Bharath Bond ETFs have a set maturity. There are no stable cash flows from Bharath Bond ETFs since they serve as growth funds where interest received is reinvested.
Bonds and debentures
Bonds and debentures are instruments of debt investment that have a Fixed Rate of Return and Fixed Maturity term. Bonds are securities which are often issued by the government, while companies issue debentures. Bonds and debentures are sold by firms to raise investor capital as a credit used to achieve corporate targets such as entering new markets, initiating a new project, or scaling the business.
Fixed interest payments (coupons) are regularly made on pre-specified dates for any bond/debenture issue. On the pre-specified maturity date, the principal loan sum (face value per unit of Bond/Debenture) is repaid. Bonds are tradable: at the current market price, an investor may sell or purchase bonds in the secondary market.
Interest rates differ from issuance to another, but they are usually higher than the Fixed Deposits and other fixed-income options.
Interest earned on bonds is not subjected to a deduction from the TDS. However, if the bond is sold off in between or when a reduced price bond matures at face value, the capital gain tax will be applicable. Tax-free bonds are 100 percent tax-free: interest income would not cause taxpayers to spend a single penny.
Benefits
- Bonds offer regular cash flows which come with a set term to enable investors to focus on returns on bonds.
- At any time, investors are allowed to sell bonds in the secondary market.
- Investors can resell and collect capital gains if the bond’s price value grows.
- A borrowing against bonds is allowed for investors. You don’t need to sell your bonds to meet your emergency needs. You can use loans and continue to hold bonds, or you can sell them whenever financial dynamics are favourable.
Drawbacks
- There is a possibility of default risk exposure to investors. For instance, the AAA default risk can be mitigated by investing in high-rated bonds.
- Individual investors cannot easily access these bonds; they are not, thus, very liquid.
Conclusion: ETF bonds have no maturity. The cumulative volume of PPF that can be spent is 1.5 lakh annually. FDs can not be sold. Whereas bonds have a set maturity, the investment size is not capped, and they can be exchanged.
There is no maturity option in the ETF bonds. In a PPF, you can invest maximum up to ₹ 1.5 lakhs. Fixed deposits are not tradable. Bonds have a set maturity, and the investment size is not capped.
All investment instruments have their own set of benefits and drawbacks, so investors must balance their financial and investment priorities. We hope this writeup helps you to understand the Fixed Income Market so that you can make your investment portfolio more diversified and balanced.
