Seasoned investors, perhaps, need no introduction about investing in bonds, but most of the individuals from the Gen-Z, are new in the world of investing and want to follow proper allocation by investing in various asset classes. They may not be too familiar with bond investing.
The Indian bond market can be broadly divided into five different categories depending upon the interest repayment schedule and credit rating. While some of these are open for subscription on an ongoing basis, others are available as and when the issue opens.
What Are Bonds?
A Bond is simply a contractual agreement between a borrower and a lender of money. The borrower enters into a contract to return the money it took from the lender along with interest which can be both fixed and variable and at a predefined time.
“A bond is equivalent to giving debt/loan to the government or a corporate entity (an issuer). In return, you get a promise to receive assured or guaranteed interest and your principal back over time of maturity date/s mentioned at the time of offer by the issuer. Thus, investing in bonds provides investors a return in the form of periodical payments and the eventual return of principal at maturity,” says Rajan Pathak, MD and Co-founder, Fintso, IT infra developer for distributors.
These types of bonds have their interest rate and repayment schedule fixed at the time of issuing the bond. In India, most State, and Central government bonds are issued using this mechanism and hence these are considered secured. Various corporate houses also issue bonds using this mechanism but those can either be secured by a charge or lien on any asset or unsecured, depending upon the terms of the issue.
“A financial entity releasing a secured bond i.e. backed by assets has a higher probability of recovery of the amount invested than an unsecured bond i.e. not backed by anything even though both bonds have the same default risk which is benchmarked by the rating given by rating agencies,” says Anshul Gupta, co-founder of Wint Wealth, a financial services company.
These bonds are available all the time and retail investors can purchase them directly either through stock exchanges or RBI retail direct scheme available on the central bank’s website.
This type of bond carries no interest payment obligation; rather they are issued at discount to their face value. For example, suppose a bond worth Rs 1000 is issued by the bond issuer at Rs. 950 with 0 per cent interest. Then on completion of the investment tenure, the bond issuer will redeem the bond at Rs. 1000. So you are buying a bond for Rs 950 and later getting Rs1000 on completion of the investment tenure. Rs. 50 is your bond investment earning income. In India Treasury Bills (T-Bills) are issued by the Central Government using this mechanism.
“Zero coupon bond is useful when there is a specific amount needed for a goal after a set period of time, where the investor does not want to take risks associated with the equity markets. Bonds will form part of the allocation to debt investments from the point of view of asset allocation,” says Lovaii Navlakhi, Managing Director and CEO, International Money Matters, a SEBI registered financial planning-cum-investment advisory company.
Zero coupon bonds, which come under the umbrella term Treasury Bills, can be purchased by retail investors using the RBI Retail Direct Platform.
These types of bonds carry no fixed interest repayment amount. At the time of issue, the interest rate is linked with the benchmarked market rate of lending interest rate. The Floating Rate Savings Bonds, 2020 (Taxable) was issued by the Central Government using this mechanism and the RBI specifies its interest rate every 6 months.
It has a fixed tenure of seven years with no premature redemption option for people below 60 years of age.
“Selection of this type of bond is dependent on financial goals, required safety, etc. Keep in mind these bonds have a lock-in period and to that extent illiquid. Therefore consider only part allocation,” says Gaurav Mashruwala, a certified financial planner and author of Yogic Wealth, a financial planning firm.
These are issued at specific intervals, last time it was issued in 2020.
These bonds, issued by the RBI on behalf of the Central Government are for people who want to invest in gold without physically taking delivery of them. The bonds are issued and redeemed at the rate of gold provided by the Indian Bullion and Jewellers Association (IBJA) prevailing at that time. It carries an interest rate of 2.5 per cent per annum which is taxable as per the Income Tax Act.
“The bond’s issue price is based on the price of one gram of gold. Unlike most bonds that return the principal at maturity, the maturity value of SGB is determined by the value of the gold. Also, the bond provides an annual coupon of 2.5 per cent on the initial investment,” said Rajan Pathak, MD and Co-founder, Fintso, a deep tech-enabled platform as a service (PAAS) for financial advisors, product manufacturers and vertical aggregators.
These are issued frequently. Last time, it was available for five days until January 14, 2022. Everyone can buy them easily in some bank branch and stock exchange.
These bonds, issued by infrastructure companies like NHAI, L&T, SIDBI, NABARD, REC, and others, provide investors with an opportunity to earn a completely tax-free interest income. The interest income from such specified tax-free bonds is exempted from taxation under section 10(15) of the Income Tax Act, 1961. The Central Government in its official gazette specifies such types of bonds.
These are issued through notifications in the official Central Government Gazette. Mutual funds have specific schemes which target investments in these bonds. Some of these mutual fund categories are Axis Floater Fund, Motilal G-Sec Fund, Money Market Fund(T-Bills).
Although, a good investment opportunity, but one should always remember that bond carries a default risk except sovereign bonds. So, deciding on a bond could be a tough job for new investors and should think thoroughly before deciding the type of bonds, one can go for.
