3 min read Apr 1, 2024
Investors with a conservative risk profile often seek investment avenues that are safe, secure, and provide steady returns. Two popular choices that commonly fall into the fixed income category are Bonds and Fixed Deposits (FDs). While both offer similarities such as low risk and fixed returns, they differ in other parameters. Understanding these similarities and differences can help you make better investment decisions.
Bonds vs Fixed Deposits: Quick comparison
Definition
Bonds are debt instruments issued by corporations or governments to raise capital. When you purchase a bond, you lend money to the issuer for a specified period, which results in regular interest payments and the return of the principal amount at maturity. Fixed Deposits (FDs) are financial instruments offered by banks or financial institutions. You deposit a lumpsum amount for a fixed tenure at a predetermined interest rate.
Issued by
Governments, corporations, municipalities, or states issue bonds, offering a range of options with varying risk levels. Bonds issued by corporations, also known as non-convertible debentures (NCDs), typically offer higher returns than government bonds due to underlying credit risk. Government bonds, backed by the sovereign, are considered safer due to the absence of credit risk. FDs, on the other hand, are solely issued by banks, post offices, and financial institutions, providing a relatively secure investment avenue.
Returns
Returns from bonds originate from two primary sources: coupon payments, which are fixed interest payments made by the bond issuer, and price appreciation or depreciation in the secondary market. Bond prices can fluctuate due to factors such as changes in interest rates, credit risk, and market conditions. Lower interest rates often lead to higher bond prices (appreciation), while higher rates can cause prices to fall (depreciation). The yield to maturity (YTM) reflects the total return an investor can expect from a bond if held until maturity, considering both coupon payments and potential price changes.
The primary distinction between bonds and fixed deposits lies in their return potential. Bonds typically offer higher returns, albeit with accompanying risks such as credit or interest rate risk, which vary depending on the specific bonds chosen. Fixed deposits guarantee fixed returns, but the interest earned is taxable based on your tax slab. This taxation aspect varies among banks. Additionally, fixed deposits offer ease of investment, providing secure and guaranteed returns with minimum investment periods as low as 7 days.
Risks
Bonds can be issued by governments, corporations, municipalities, or states, providing a range of options with differing risk levels. Government bonds are considered safer than non-convertible debentures (NCDs) due to the government's backing. Within NCDs, debentures with higher credit ratings are generally safer than those with lower ratings.
In case of fixed deposits (FDs), the amount deposited is insured up to ₹5 lakhs by the Deposit Insurance and Credit Guarantee Corporation (DICGC), a subsidiary of the RBI (Reserve Bank of India).
Liquidity
Bonds represent liquid assets tradable in the secondary market. However, this liquidity often accompanies market volatility stemming from underlying interest rate risk. Fixed deposits offer enhanced liquidity by permitting premature withdrawals, albeit with some penalty charges.
Frequency of payout
Bonds typically pay interest either half-yearly or annually or cumulative at maturity. In FDs, you can choose the payout frequency from monthly, quarterly, annually or cumulative at maturity.
Credit ratings
Bonds commonly undergo credit rating assessments by agencies, evaluating the issuer's creditworthiness and default probability. These ratings range from AAA to D, with AAA denoting the highest rating. Conversely, fixed deposits issued by banks typically do not receive credit ratings.
Choosing between Bonds vs FDs: Factors to consider
Choosing between bonds and FDs depends on various factors such as risk appetite, investment objectives, liquidity needs, and investment horizon. Bonds offer high returns but entail additional risk. FDs, on the other hand, offer relatively lower but guaranteed returns. A combination of FDs and bonds can be a good strategy for diversifying your fixed income portfolio.
Also Read: Fixed Deposit (FD) rules and regulations in India
Conclusion
In the FD vs Bonds tug-of-war, there's no one-size-fits-all answer. Each avenue has advantages and disadvantages while catering to varied investor preferences. You must assess your needs and goals to create a well-diversified portfolio for financial success.
Disclaimer: This article is for information purpose only. The views expressed in this article are personal and do not necessarily constitute the views of Axis Bank Ltd. and its employees. Axis Bank Ltd. and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.
