Fixed-income instruments are debt instruments that pay investors regular interest payments in addition to repayment of principal at maturity. In India, fixed deposits and government bonds are popular fixed-income instruments. Investors with a low-risk tolerance tend to prefer fixed-income securities.
However, government bonds and fixed deposits differ on various counts. It is essential to understand these distinctions to decide your financial goals and risk preference. Let’s delve deeper into the topic.
What is a fixed deposit?
It refers to a financial instrument where you, as an investor, can deposit money for a specific time with a predetermined interest rate. In this case, the interest and principal are payable on maturity. Banks, post offices, and non-banking financial companies provide fixed deposits. FDs are flexible, meaning you can withdraw money at any time. But you must remember that premature withdrawal charges may apply.
Here are some of the salient features of FDs:
- The tenure can range from seven days up to 10 years.
- Once the FD matures, the investor can reinvest the returns in a new fixed deposit account. Several banks offer this feature and call this rollover term.
- FDs for senior citizens can offer higher interest rates than traditional FDs.
- While fixed deposits fetch a fixed interest rate, market fluctuations will not hamper the returns.
- Tax-saver FDs come with a lock-in period of five years. When you invest money in those fixed deposits, you can claim tax exemptions under Section 80C of the Income Tax Act.
- You can pledge the deposits as collateral to avail of loans.
What are government bonds?
A bond is a debt instrument, a loan made to the borrower by the investor. At maturity, the principal needs to be paid, and until then, investors will continuously get regular interest income in return. Companies and government bodies use this debt instrument to raise funds for ongoing operations, new projects, acquisitions, etc.
Basically, bond issuers need to borrow money from investors for a specific tenure in exchange for periodic interest payments, which can be monthly, quarterly, or annually. Bonds have fewer risks than equities, making them key components of a well-diversified investment portfolio. However, bonds are not risk-free as they come with inflation, credit, and interest rate risks.
The interest rate on bonds is slightly higher than that of fixed deposits.
Credit quality is a vital factor in deciding a bond’s interest rate. If the issuer has a low credit rating, there is a greater default risk. Therefore, these bonds can provide more interest. If you are the issuer, it will help the company to meet short/medium, and long-term capital needs. Bonds have lower risks than equity instruments.
Here are some of the features of bonds:
- Bonds come with higher liquidity to realize profits before maturity on account of price appreciation.
- They tend to be less volatile and risky than stocks. But they can provide stable returns when held to maturity.
- Bonds provide slightly higher returns than savings bank accounts and other traditional investment avenues.
- Besides, bonds can provide greater diversification to the portfolio to offer better returns adjusting risks.
Who should invest in fixed deposits?
If you want to invest your money safely, you must analyze whether the fixed deposit is the right financial instrument.
You should know that FD is ideal for:
- Investors who need a medium to long-term investment avenue with low risk.
- Those who are unwilling to stomach variable interest.
- Those willing to diversify risks in the investment portfolio.
- Investors can access different market-linked instruments offering better returns. Remember that better returns have more risk.
- If you are an investor, you need to think about secure investment possibilities along with trying to protect and grow capital.
Who should invest in government bonds?
There is no shortage of fixed-income instruments in the Indian financial market. Choosing one that suits your goals and risk appetite is up to you. Government bonds might suit the following category of investors.
- It is perfect for investing for those people with low-risk tolerance.
- People who want to have a steady source of income.
Government bonds vs. fixed deposits
Government bonds and fixed deposits vary on several parameters.
State governments, municipalities, central governments, private companies, and PSUs issue bonds.
Post offices, banks, and non-banking financial companies (NBFCs) issue fixed deposits.
Physical assets back up the bonds, due to which these are safe. You can check the issuer’s credit rating.
Fixed deposits are safe instruments, but you should know that physical assets don’t back these. Choosing a safe institution is essential to open an FD.
Listed bonds trade on the stock exchange, ensuring liquidity.
Investors can withdraw the fixed deposit before maturity. However, a penalty and lower interest rates might apply.
According to the term structure of the bond, investors cannot select the payout frequency.
In FDs, investors can select the payout frequency as required.
Bond returns are slightly higher than FDs.
Fixed deposits give a fixed return on the invested money.
All bond issuers should have a credit rating.
For FD issuers, NBFCs need to have a credit rating. However, it is non-essential for banks/ post offices that offer FDs.
Capital gains tax on bonds depends on the holding period. Select bonds issued by government institutions are tax-free.
Regarding FDs, tax is applicable per the individual income tax slab. However, tax-saving FDs that come with a five-year lock-in period are exceptions.
It is hard to say which instruments one should choose: government bonds or FDs. Remember that the answer depends on why you invest money, your investment horizon, and how you understand the risks. Investors can make good decisions considering the pros and cons.