Bonds and Fixed Deposits (FDs) are amongst the most popular fixed-income instruments. Both are beneficial for investors with a low-risk tolerance looking for fixed-income securities. However, they differ from each other on various parameters. It is essential to develop an understanding of both these instruments and invest according to your individual goals and risk preference.
So rather than simply comparing Bonds vs Fixed Deposits, we will empower you to make a sound decision in picking the right investment alternative.
What are Bonds?
Bonds are a type of debt instrument used by companies and government bodies to raise funds in order to fund ongoing operations, new projects, acquisitions, etc.
Bond issuers borrow money from investors for a particular tenure, in exchange for periodic interest payments (monthly, quarterly, or annually). At the time of maturity, the investor is also re-paid the principal amount. The interest rate can be either fixed or floating, based on the terms of the contract between the issuer and the lender.
Bonds are generally less risky than equities, making them an important component of a well-diversified investment portfolio. However, they are not entirely risk-free as they carry inflation risk, credit risk and interest rate risk.
Also Read: Why Do Stock Prices Fluctuate?
Features of bonds
- The interest rate on bonds is usually slightly higher than that offered by FDs and is paid quarterly, monthly, semi-annually or annually.
- Credit quality is one of the principal determinants of a bond’s interest rate. If the bond issuer has a low credit rating, it is implied the default risk is greater, and as a result, such bonds offer more interest.
- In the event that the company declares bankruptcy and is subsequently liquidated, the bondholders will be paid before the stockholders.
- On the issuer’s side, bonds help the organisation meet short/medium and long term capital requirements.
- Bonds have a low risk exposure as compared to equity instruments.
Benefits from bonds
- Listed Bonds have relatively higher liquidity and this makes room for realising profits prior to maturity on account of price appreciation.
- Bonds tend to be less volatile and risky than stocks, and when held to maturity they offer stable and consistent returns.
- Bonds offer higher returns than savings bank accounts and many other traditional investment avenues.
- Bonds offer greater diversification to your portfolio, thus providing better risk-adjusted returns.
Who Should Invest in Bonds?
The financial market offers several financial instruments, and it is essential to identify which instrument is the best for you. The following category of people can consider investing in bonds:
- Investors with low-risk tolerance should invest in bonds.
- People who are looking for a steady source of income.
- Investors prefer stable predetermined returns over uncertain investment avenues with considerably higher potential returns.
Also Read: Best Investment Plan for Monthly Income
What are Fixed Deposits?
Fixed deposits (FDs) are provisions in which investors invest a fixed sum of money for a specified period to earn a pre-fixed return. FDs are provided by banks, post offices and non-banking financial companies. They offer a fixed rate of interest for a fixed tenure.
At the maturity of FD, the investors are paid the interest and the principal. FD comes with the flexibility of easy withdrawal at any time. However, premature withdrawal is subject to penalty charges or reduced interest rates.
Also Read: Top 9 Alternatives to FD
Features of fixed deposits
- The tenure of an FD can range from a minimum of 7 days up to 10 years.
- After maturity, the returns obtained from the FD can be re-invested in a new FD account. This feature is provided by several banks and is called Rollover Term.
- There are fixed deposits for senior citizens that provide higher interest rates than traditional FDs.
Benefits of fixed deposits
- They offer a fixed rate of interest and market fluctuations do not hamper the returns.
- You can invest in tax-saver FDs that have a five-year mandatory lock-in period. By investing in these FDs, you can claim tax exemptions of up to Rs 1.5 lakh under Section 80C of the Income Tax Act.
- FDs can be pledged as collateral to avail of loans.
Also Read: Why Do Stock Prices Fluctuate?
Who Should Invest in Fixed Deposits?
To invest safely, it is essential to analyse whether FD is the right financial instrument for you or not. A fixed deposit is the best option for:
- Investors looking for medium to long-term investment avenues with low risk.
- Investors who don’t want to deal with the hassle of variable interest.
- People who want to diversify the risk in their investment portfolio.
As investors, you have access to a variety of market-linked instruments that provide better returns. However, these enhanced returns also come with considerably enhanced risk. It is prudent for an investor to think about secure investment possibilities while seeking to protect and grow capital while seeking to protect and grow capital.
Also Read: FD Interest Rates Comparison
Bonds vs Fixed Deposits: Quick Comparison
|Definition||It is a financial means through which companies and government bodies raise funds for their operations. The investors get regular interest income, and the principal amount is usually payable on maturity.||It is a financial instrument where the investor deposits money for a specific period to earn a predetermined interest rate.|
|Issued by||Bonds are issued by municipalities, state governments, central governments, private companies, and PSUs.||FDs are provided by post offices, banks, and Non-banking Financial Companies (NBFCs).|
|Collateral||Secured Bonds are backed by physical assets. These assets safeguard investors against an array of risks.||Unlike bonds, they are not backed by physical assets. However, DICGC offers insurance to each depositor, of up to Rs. 5 lakhs on principal and interest.|
|Liquidity||Listed Bonds are traded on the stock exchange, which enhances their liquidity.||Investors are free to withdraw the FD before maturity. But, such withdrawal leads to reduced interest rates or penalty charges.|
|Frequency of payout||Investors are not free to choose the frequency of payout as dictated by the bond’s term structure.||Investors are free to choose the frequency of payout.|
|Returns||Bonds generally offer higher returns than FDs.||FDs offer a fixed return on investment.|
|Credit Ratings||Mandatory for bond issuers.||FDs issued by NBFCs should carry a credit rating, but banks/ post offices are not required to provide credit ratings.|
|Taxes||Capital gains from bonds are taxed per their holding period. However, they are tax-free bonds issued by government institutions like PFC, REC, NTPC, IREDA, HUDCO, and IRFC.||Fixed deposits are subject to income tax per the individual income tax slab. Also, TDS is deducted at 10% if the interest income exceeds Rs. 40,000 and Rs.50,000 in the case of senior citizens.|
|Tax-Saving under Section 80C||Not applicable to bonds.||Tax-saving FDs allow a deduction of up to INR 1.5 Lacs.|
Should retail investors consider including bonds in their portfolios?
Bonds can be a good addition to a retail investor’s portfolio as they offer a way to diversify and manage risk. By including both stocks and bonds in your portfolio, you can potentially reduce the volatility of your overall investment returns.
However, retail investors should keep in mind that the value of bonds can fluctuate, and there is a risk of default if the issuer is unable to make its payment obligations. It is important to carefully consider the creditworthiness of the issuer and the terms of the bond before making an investment.
Retail investors should also be aware of the risks associated with bonds, including credit risk, interest rate risk, and inflation risk. It is a good idea to diversify your bond portfolio by investing in bonds with different maturities, credit ratings, and sectors to manage risk.
It is always a good idea to consult with a financial advisor or professional before making any investment decisions. They can help you understand the risks and potential rewards of different investment options and create a balanced portfolio that is tailored to your financial goals and risk tolerance.
Also Read: Fixed Deposit vs Liquid Funds – Which Instrument is Best for Your Portfolio?
Bonds vs. FDs – Which is Better?
After understanding how bonds and FDs work, you can easily choose the investment instruments that suit you the best. Bonds and FDs come with an array of distinct variations promising to meet a variety of investment needs. Bonds offer higher returns on maturity than FDs.
FDs are better if you are looking for long-term, risk-free, and easily accessible investment instruments. Depending upon your risk appetite, you must make the decision to choose between FDs or bonds. You can also choose a mix of both for portfolio diversification based on your requirements.
It is tough to say who wins the war in FD vs bonds. The answer lies in your investment goals, investment horizon, and understanding of risk. These factors are instrumental in helping investors make an informed decision.
You should choose the financial instrument after conducting a detailed analysis of your needs.
FAQs related to Bonds vs FDs
What is credit risk in bonds?
Credit risk or default risk refers to the possibility that a bond issuer will default on their payments of interest and/or principal. Government bonds are generally considered to be immune from default and have negligible credit risk. However, corporate bonds are much more likely to be defaulted on, since companies can go bankrupt.
Who issues bonds?
In India, bonds are majorly issued by Central Government, State Governments, Municipality Corporations, NBFCs, Banks, Corporations, and Public Sector Undertakings.
What are corporate FDs?
Corporate FDs, or company FDs, refer to the term deposits provided by a company for a fixed period promising fixed interest rates. Various non-financial and financial banking institutions offer corporate FDs. The maturity period, or tenure, ranges from a few months to years, contingent on the company’s requirements.
What is the taxation on FDs?
Interest earned on Fixed deposits is subject to income tax per the individual income tax slab rate. Further, if you are a PAN user and receive an interest of over Rs. 40,000 (Rs.50,000 for senior citizens) on your FDs, you will be liable to pay 10 percent of it as TDS. Non-PAN users have to pay 20% on account of the same.
Which is a better investment: bonds or fixed deposits?
The best investment for you depends on your financial goals, risk tolerance, and investment horizon. If you are looking for a low-risk investment with a guaranteed return, fixed deposits may be a good choice. However, if you are willing to take on more risk in exchange for potentially higher returns, bonds may be a better option. It is always a good idea to diversify your investment portfolio and include a mix of assets, such as stocks, bonds, and cash, to manage risk and maximize returns.
Chandhana is a budding investment professional with growing expertise in the capital markets. She has completed her Bachelors in Business Administration with a specialisation in Finance from Christ (deemed to be) University,Bangalore. She is also a CFA L2 candidate. She is currently working as an Investment Associate at Wint Wealth.