Bond prices are inversely linked to interest rates. When interest rates go up, bond prices fall and vice versa.
Have you considered investing in bonds? These are traditional investment options wherein the issuer, be it the government or the corporate entity agrees to pay the investor interest at the pre-decided interval. Depending upon the terms of the bond, the interest payment frequency can be monthly, quarterly, half yearly, annually or at the time of maturity. Such interest pay-outs are termed as coupons in industry jargon. Some bonds do not pay interest but issued at a discount to face value. For example, a bond may be issued at Rs 1000 and the bond issuer will pay Rs 2000 at the time of maturity seven years from the date of issue. Such a bond does not pay any interest and hence termed as Zero Coupon bond.
Corporate Bonds and Government Bonds
Corporate bonds are debt securities which can be issued either by private and public corporations. In some cases, the bonds are listed on the stock exchanges. Depending on the credit rating of the issuer the investor can get an idea of the credit risk he is exposed to. For example, a bond with AA rating is seen as a riskier bet as compared to a bond with AAA rating. No wonder the bond with AA rating will pay more interest as compared to a bond with AAA rating for the same term.
Bond prices are inversely linked to interest rates. When interest rates go up, bond prices fall and vice versa. As bonds are tradable securities one may see marked to market losses, if the interest rates go up. If held until maturity of the bond, the investor gets his money back.
“While investing in bonds investors get a fixed return at a stipulated time, irrespective of the performance of the company. These securities tend to give a better overall return than traditional fixed income security like savings bank account, fixed deposits, Treasury bills, etc. Bonds are mandatorily rated by rating agencies. The higher the rating, lower is the rate of return,” Abhinav Angirish – Founder – Investonline.in told Moneycontrol.
While fixed deposits are currently, providing around 6 to 7 percent returns, bonds can give you an average return ranging from 6.5 to 8 percent.
Individual investors can choose to invest in 7.75% Savings (Taxable) bonds issued by RBI. This bond comes with a seven-year term and offers a rate of interest at the rate of 7.75 percent. The interest on these bonds is taxable under the Income-tax Act. The bonds are issued with a minimum face value of Rs 1000 and has no upper capping. Though the bonds have an elongated tenure of seven years, senior citizens can opt for premature encashment subject to norms.
If you are savvy, you may also want to check the yields on the tax-free bonds issued earlier by many governments backed corporations, in the secondary market. Yields on these bonds are quoting in the range of 6.1% to 6.2%. Please note that these bonds quote at a premium to their face value and offer interest in the range of 7.75% to 8.75%. These bonds were originally issued for 10-15 and 20 years. You would be better off checking the residual maturity and prevailing yields before biting the bullet.
What is the tax treatment?
“Tax-free Bonds are totally exempt from tax. These bonds are in most cases issued by the government for development purposes and are totally tax exempt, by which it gets the name Tax free Bonds. The interest income earned from investing in these bonds are free from taxation as per the Section 10 of the Indian Income Tax Act, 1961,” he said.
Unless otherwise stated, interest paid on all bonds is added to the income of the investor and taxed at marginal rate of tax. If you trade in bonds, then the capital gains earned on the bonds are also taxed.
Who should invest?
Risk-averse investors, retired individuals should ideally look at these kinds of instruments. There is no specific time to invest in these bonds unless one is willing to bet on the interest cycle which is meant for seasoned professionals. Investors should ideally look at investing in high-rated bonds for safety. However, those who are willing to take a slight risk of default can go for a lower-rated debt which gives a higher return.
Why bonds can become more attractive in the long run
Debt in long-term portfolios play three major roles: first, offering liquidity and income comfort from the portfolio, second: to lower volatility in the portfolios, which is a huge emotional cost to investors and third: giving the investors the option to have the cash to invest, when equities are beaten down.
Himanshu Kohli, Co-Founder, Client Associates said that generating outsized returns from the debt over long periods is typically not one of the major goals of debt portfolio allocations. Over longer periods, we believe investors should expect inflation plus some excess return from debt. Tactically speaking, for the last couple of years, we have been in an era where the debt investments have yielded higher returns than the inflation, which was not the case till 2014-15. This has made debt allocations relatively more attractive. Going forward, too, we expect the yields on the 10-year bonds to hover in the range of 7.5% to 8%, with an upward bias. At the same time, we do not expect inflation to breach the 6% barrier. As a result, we feel that debt will still give investors a real rate of return of 1.5-2%. But, we would reiterate that over the long term, returns are typically not the reason for keeping debt in the portfolio.
“Within debt, we feel more comfortable at the shorter end of the curve, into accrual strategies for investors. We believe that duration risk via dynamic funds should be built very carefully and in small doses. Completely giving up on dynamic funds is also not recommended,” he added.
