Fixed-income investments appeal to people who want regular interest and more predictable outcomes than equities. But "fixed income" covers a wide range of instruments with very different risk profiles. Three that Indian investors commonly compare are bonds, non-convertible debentures (NCDs) and bank fixed deposits (FDs).
What each one is
- Fixed deposit: a deposit with a bank (or a deposit-taking company) for a set term at a stated interest rate. Bank deposits are covered by DICGC deposit insurance up to a specified limit per depositor per bank.
- Bond: a loan you give to an issuer — the central or a state government, a public sector undertaking, or a company — in exchange for periodic interest (the coupon) and repayment of the face value at maturity.
- NCD: a type of bond issued by a company that cannot be converted into shares. NCDs are often offered to the public through an issue and then listed on a stock exchange.
Credit rating: how likely are you to be repaid?
The most important risk in lending money is that the borrower fails to pay. Rating agencies registered with SEBI assess this credit risk and assign ratings, with AAA indicating the highest relative safety and lower grades indicating progressively higher risk. Two points are worth remembering. First, a rating is an opinion about the issuer's ability to pay, not a promise — ratings can be downgraded. Second, a higher interest rate is usually compensation for higher risk. If one issuer offers noticeably more than others with a similar tenure, ask why.
Yield: what you actually earn
The coupon is the interest rate on the face value. The yield is what you earn based on the price you actually pay. If you buy a listed bond in the secondary market above its face value, your yield is lower than the coupon; if you buy below face value, it is higher. Yield to maturity (YTM) captures this, assuming you hold until maturity and receive every payment on time.
Bond prices also move with interest rates. When rates rise, existing bonds with lower coupons become less attractive and their prices fall; when rates fall, prices rise. This matters if you may need to sell before maturity.
Liquidity: can you get your money back early?
- FDs can usually be broken before maturity, typically with a penalty on the interest rate.
- Listed bonds and NCDs can be sold on the exchange, but trading volumes in many issues are thin. You may have to accept a lower price, or wait to find a buyer.
- Some bonds carry call or put options that allow early redemption by the issuer or the investor on specified dates.
Taxation
Interest from FDs, bonds and NCDs is generally taxed at your applicable income-tax slab rate. Gains or losses on selling listed bonds before maturity are treated differently from interest, and the rules have changed in recent years. Check the current provisions, or speak to a tax professional, before comparing post-tax returns.
Questions to ask before you invest
- Who is the issuer, and what is the current credit rating — and its recent history?
- Is the instrument secured or unsecured? Where does it rank if the issuer runs into trouble?
- Is the interest paid monthly, annually or cumulatively at maturity?
- Will I definitely hold until maturity, or might I need to exit early?
- What is my return after tax, compared with alternatives of similar risk?
No single instrument is "better" in every situation. The right mix depends on how much risk you can accept, when you need the money, and how the interest fits into your tax picture.