Essential elements in diversifying your investment portfolio, bonds foster significant risk tolerance and income stability. Bonds can be a perfect fit if investors are looking for diversification, but they need to carefully consider the tax implications of bonds to make informed decisions. Simply put, bonds are debt securities issued by governments and private organisations to finance various operations. Navneet Dubey of BT Money Today spoke to Vishal Goenka, Co-founder of IndiaBonds.com, about investing in bonds.
1. Can you explain what bonds are? Where do the investments go when one invests in such an instrument?
Bonds are financial instruments that symbolise a type of financial obligation, or ‘loan’. When an individual or an entity purchases a bond, they essentially lend money to the issuer, usually a government agency or a corporation. In return, the issuer promises to repay the principal amount and make periodic interest payments over a predetermined period. Bonds are widely regarded as a fixed-income investment, providing investors with a predictable income stream.
2. Can you explain the tax implications behind it? What investors should know
The interest income from bonds is typically subject to taxation based on the individual's applicable tax bracket. Also, effective April 1, 2023, listed bonds now attract a TDS of 10% on interest income. Capital gains tax for listed bonds comes into effect on the sale of bonds at a profit before maturity or redemption at par when bought at a discount. Short-Term Capital Gains (STCG) apply for profitable transactions less than or equal to 12 months. Long-Term Capital Gains (LTCG) are applicable at a flat rate of 10% for holdings exceeding 12 months, without the provision of an indexation benefit. However, certain bonds, known as tax-free bonds, may offer interest income exempt from income tax. It's essential for investors to carefully consider the tax implications of their bonds to make informed decisions.
3. How do bonds score over fixed deposits? Can you elaborate on some of its advantages?
Bonds present several advantages in comparison to Fixed Deposits (FDs). Firstly, bonds frequently offer higher yields than FDs, potentially leading to enhanced returns while maintaining similar features to those of an FD. Secondly, bonds are tradable in the secondary market, providing liquidity and the chance to exit investments before maturity. In contrast, premature withdrawal of an FD may result in penalties. Thirdly, bonds have the potential for capital gains if interest rates decrease or issuer credit improves. Also, in terms of security, government securities benefit from a sovereign guarantee, while corporate bonds are supported by collateral. In contrast, FDs lack security and are inherently unsecured, with insurance coverage extending up to Rs 5 lakh under the Deposit Insurance and Credit Guarantee Corporation (DICGC) scheme. Additionally, the variety of bonds available allows investors to tailor their portfolios to match cash flows, risk tolerance, and investment goals, which may not be as flexible with FDs.
4. Can you let us know the risk involved in bonds compared to FDs?
While both bonds and FDs carry some level of risk, bonds generally offer more diversity in terms of risk profiles. Corporate bonds, for instance, may have a relatively higher risk than government bonds, but they also offer potentially higher yields. In contrast, FDs are typically considered safer due to their fixed interest rate. Investors must assess their risk tolerance and investment horizon before choosing between bonds and FDs.
5. As we have discussed the benefits and risks, can you give insights on the lock-in periods?
Unlike FDs, which often come with predetermined lock-in periods, bonds generally offer more flexibility in terms of maturity and exit. Investors can choose from a range of bond tenures that align with their financial goals. Furthermore, bonds can be traded in the secondary market, providing opportunities for liquidity and early exits if needed, though market conditions may impact the selling price.
6. How can bonds help portfolio diversification, regular income, tax optimisation, and give better returns than FDs?
Investing in bonds can play a pivotal role in a well-rounded investment portfolio. Bonds contribute to diversification by offering an alternative asset class that can counterbalance the volatility of equities. They also provide a reliable source of regular income through interest payments, which can be especially beneficial for retirees or those seeking a consistent cash flow. Furthermore, strategic allocation to tax-efficient bonds can aid in optimising one's overall tax liability. The potential for better returns than FDs arises from the broader spectrum of risk and return profiles that bonds offer, allowing investors to select options that align more closely with their financial objectives.
7. What is the minimum ticket size for investing in bonds?
The minimum ticket size for bond investing can vary based on the issuer and the type of bond. In primary or new issue markets, investments can be made for as little as Rs 10,000 for corporate bonds. In secondary markets, government securities can be bought for as little as Rs 1,000, and corporate bonds are usually Rs 1 lakh. It's advisable for potential investors to research and identify bonds that match their financial capacity and investment preferences.
8. How can one invest in these bonds? What is the process?
Investing in bonds can be accomplished through various channels. Investors can directly purchase bonds in primary or secondary markets through Online Bond Platform Providers (OBPPs), which are registered with SEBI. Debt Platforms can offer diverse investment opportunities, from government securities to A-rated corporate bonds with up to 12% returns. Alternatively, bonds can be bought through traditional stock brokers, and RBI Retail Direct allows retail investors to buy government bonds directly.