Fixed income debt securities like FDs are preferred widely by Indians. In a survey conducted by the Securities Exchange Board of India, we found that 90% of Indians investors, invested in fixed deposits.
Every year, Indians mobilise their small-ticket personal savings into bank fixed deposits in the hope of earning decent returns. However, many of us are still hesitant to believe that there can be other investment mediums.
In this article, we draw detailed comparisons between fixed deposits (FDs) and covered bonds to help individual investors make more informed investment decisions.
5 Main Differences Between Fixed Deposits and Covered Bonds
Here are the 5 major differences between fixed deposits and covered bonds investment, that will help investors make an informed choice.
Difference 1: What are They?
Fixed Deposit: A fixed deposit, popularly known as FD is an investment instrument that banks and NBFCs offer to investors.
The tenure of an FD is fixed. Investors earn returns at a predetermined rate of interest when they put their money in an FD for a fixed term.
A Fixed deposit’s lock-in period can vary from 7 days to 10 years and once invested, the money cannot be withdrawn. They are provided by banks as well as NBFCs.
Covered Bonds: Covered bonds are fixed-income debt securities.They are issued by financial institutions like banks (although, banks don’t need to issue covered bonds as they have access to public funds) and NBFCs.
A covered bond, is like any other bond but with an extra layer of security. However, there are certain risks which can be associated with a covered bond, which makes it a high risk — high returns
Difference 2: The Risk Factor
Fixed Deposit — When it comes to risk, FDs are a comparatively safer option. However, one should remember that their risk is low, but the returns are also significantly lower as compared to many other investment options.
However, investors must note that FDs also fluctuate mildly, based on market conditions. The current interest rate given by an FD is 5–6% p.a.
Covered Bonds — Covered bonds on the other hand have a high risk — high returns structure.
Covered bonds provide an extra layer of security to investors, however, there are certain risks involved in this of investment, namely fraud, liquidity and credit risk.
Difference 3: Who Should Invest in Them?
Fixed Deposits: FDs are ideal for investors who have a low risk appetite and have a substantial amount of money to park, without having to withdraw it for a certain time frame.
However, if an investor wants a high rate of return, along with liquidity, a fixed deposit may not be their cup of tea.
Covered Bonds: Covered bonds can be ideal for people who already have a basic understanding of how the debt market works ,who want to diversify their portfolio and beat inflation, while earning risk-adjusted returns.
Difference 4: Tax Exemptions and Taxation
Fixed Deposit: Only certain types of FDs, known as tax saving fixed deposits can provide a tax deduction of upto Rs. 1,50,000 under the Section 80 C of the Income Tax Act.
Covered Bonds: As of now, investing in covered bonds will not provide investors any sort of tax exemption.
However, some covered bonds (MLDs) may provide better post tax returns. Also, investors should note that listed bonds do not have any TDS deductions.
Difference 5: Liquidity
Fixed Deposits: Fixed deposits mature on a fixed date and the rate of interest is calculated based on the principal amount and tenure.
Investors can prematurely withdraw their money but they bear a penalty for the same. Therefore fixed deposits are liquid, but that liquidity comes at a price.
Covered Bonds: They mature at a fixed date and the rate of interest can be paid to investors either monthly or even at the end of the tenure (also called, bullet payment).
Through platforms like Wint Wealth, If an investor wants an early payout, they can withdraw their investment amount.
However, this is possible, only if the company finds another investor to replace them. If a suitable investor is not found, withdrawing will not be possible and the current investor will have to remain invested till the end of the tenure.
Fixed Income Instruments: Market Analysis 2021
Equity has always been a volatile option. And most seasoned investors prefer balancing their equity portfolio with debt options that can strengthen their portfolio.
In 2021, cautious investors are using asset rebalancing to shift from equity investment to debt investments.
While FDs have been a popular avenue for retail investors looking to park cash and earn guaranteed returns, the promised interest rates are not very appealing, if an investor wants to accumulate substantial wealth.
In fact, as per a recent RBI publication, ‘Handbook of Statistics on the Indian Economy’, fixed deposits with 5 years have seen a decline in the year 2019–2020, in comparison with 2018–2019.
In comparison, looking at the settlement data of April 2021 on the SEBI website, there is a stellar upward surge throughout the month. The trend is likely to continue as more people shift from equity’s uncertainty to debt’s reassurance.
Indians are now open to trying out other debt instruments like debt mutual funds and covered bonds. These instruments are safer than equity, but provide higher returns than traditional debt instruments like fixed deposits, recurring deposits and savings bank accounts.
For example, covered bonds carry high risk, but they provide fixed returns to investors. The fact that they are comparatively less risky than equities, can be a huge plus to Indian investors, who were previously sceptical to invest in alternate investment options.
To choose between fixed income debt instruments like fixed deposits and covered bonds, investors must assess their own risk appetite, and return expectations. If you are an investor who has a low risk appetite, fixed deposits may work in your favour.
However, if you are looking for a high risk but better return investment option, covered bonds can be a better option. However, as mentioned before, it is riskier.
Although covered bonds are a relatively new investment option, they offer a structured investment option to matured investors.