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Bonds and fixed deposits are both fixed-income instruments, which pay fixed returns at periodic intervals or make cumulative interest payments on the maturity date. However, these fixed income options can differ significantly in terms of returns, risk, liquidity, taxation, etc. Understanding these differences can help you make informed decisions while choosing between fixed deposits and bonds.
Table of Content :
What are Bonds?
Bonds are fixed-income instruments issued by governments and companies, both public and private sector companies, to raise funds for meeting various financial requirements. When an investor purchases a bond, they actually lend money to the issuer and receive interest (coupon) payments in return. Bonds can either be listed or unlisted. Listed bonds allow higher liquidity to their investors as they can be traded on the stock exchanges. You can invest in highly rated (AAA-BBB) corporate bonds online through Paisabazaar and earn fixed returns of up to 13.25% p.a.
Features & Benefits of Bonds
- Consistent Income Stream: Bonds generally pay fixed interest at regular intervals, helping investors earn consistent income.
- Capital Preservation: The principal amount is repaid at maturity, making bonds suitable for those prioritising capital protection during market fluctuations.
- Risk Diversification: Adding bonds to a portfolio can help balance the risk of more volatile investments like equities.
- Lower Market Fluctuations: Bonds tend to experience less price fluctuation than stocks, making them a stable investment option for conservative investors.
- Returns Certainty: The fixed interest payments and assured principal repayment on maturity make it easier for bond investors to plan their investment as per their cash flow requirements.
- Scope for Capital Gains: While bonds are usually purchased for interest income, these can also yield capital gains if sold or redeemed at a price higher than the purchase price.
- Longer Tenure Options: The tenure of bonds can go up to 40 years, with perpetual bonds having no maturity dates. Such long tenure options allow one to invest in bonds for longer periods at very attractive yields, as and when available.
What is a Fixed Deposit?
Fixed Deposit is a fixed-income instrument offered by banks and NBFCs, through which a depositor deposits a lump sum amount for a specific tenure and earns interest at a predetermined interest rate. FDs can offer interest payouts at periodic (such as monthly, quarterly and half-yearly) intervals or pay cumulative interest at maturity.
You can easily estimate your FD’s maturity value and interest income using Paisabazaar’s online FD Calculator. The tool requires only a few basic inputs, such as deposit amount, FD interest rate, and tenure to give you instant results. You can also book an FD online (without opening a bank account) through Paisabazaar and earn an interest rate up to 8.05% p.a.
Currently, scheduled banks offer interest rates of up to 8.50% p.a. for regular depositors for tenures ranging from 7 days to 10 years. Small finance banks and NBFCs offer the highest FD interest rates.
Features & Benefits of FD
- Fixed Returns: Offers predetermined interest rates with non-cumulative or cumulative payout options.
- NIL Market Risk: FDs are not affected by market fluctuations as they are not traded on exchanges.
- Flexible Tenure: Tenure ranges from 7 days to 10 years, allowing investors to choose their tenures as per their financial goals.
- Liquidity (Callable FDs): Callable FDs can be closed before their maturity date. However, banks usually levy a penal rate on premature withdrawal of FD.
- Tax Deduction under Section 80C: Banks and Post Office offer Tax Saving FDs wherein the deposits of up Rs 1.5 lakh per financial year can be claimed for tax deduction under Section 80C. These FDs have a 5-year lock-in period and their interest income is taxed as per the tax slab of the depositor.
Difference between Bonds and FD
FDs are often a safe bet for risk-averse investors seeking guaranteed returns. Investments in bonds are suitable for those seeking regular income, portfolio diversification and higher returns compared to fixed deposits. However, it’s important to consider the issuing company’s creditworthiness, understand the associated risk and choose investments that align with your financial goals rather than chasing higher returns.
| Distinction | Bonds | Fixed Deposit |
| Issuers | Governments & Companies (both public & private sector companies) | Banks, Post Office and Select NBFCs |
| Returns | Summation of interest income and capital gains, if any | Consists only of interest income; no scope of capital gains |
| Price fluctuations | Bond prices may rise/fall due to changes in interest rate cycles, credit rating upgrades/downgrades or other market factors | No price fluctuation as bonds cannot be traded or transferred |
| Liquidity | Listed bonds can be sold in the secondary market, subject to their trading volume | Callable FDs can be closed before their maturity date . Non-callable FDs cannot be withdrawn before maturity, whereas tax saver FDs have a 5-year lock-in period |
| Risk | Subject to various kinds of risk, including credit (default) risk, interest rate risk, prepayment risk, liquidity risk, call risk, etc | Bank FDs have much lower risk and are also backed by depositor deposit insurance. However, corporate FDs are subject to credit (default) risk |
| Credit Rating | Rated by agencies like CRISIL, ICRA, CARE, etc. | FDs are not rated, except for corporate FDs |
Returns
Just as in the case of fixed deposits, returns generated from bonds held till their maturity dates would consist of the interest payments received at pre-set periodic intervals or cumulative interest payments received on their maturity dates. However, listed bonds traded on stock exchanges may witness price gains due to falling interest rates, credit rating upgrades or other favourable market conditions. Thus, investors of listed bonds can also benefit from rising bond prices by selling them in the stock exchanges before their maturity dates.
Risk
While bonds offer the scope of generating additional returns through capital appreciation, factors like rising interest rates, credit rating downgrades or other unfavourable market conditions may also lead to a fall in the bond prices. This leads bonds to carry a varying degree of market risk for investors who do not wish to stay invested till their maturity dates. The only exception is floating rate bonds, whose coupon rates keeps on changing as per the changes in their linked benchmark rates, making them less susceptible to interest rate risk. Similarly, bonds also carry credit risk or default risk — the possibility of the bond issuer defaulting on its future coupon or maturity repayments. Government bonds carry the lowest credit risk due to their sovereign backing. Within the corporate bond category, those with higher ratings, typically AAA to BBB, carry lower credit risk than others.
Fixed deposits do not have market risk as they are not traded on the stock exchanges. However, bank FDs carry credit risk due to the risk of bank failures. This risk has been reduced for the depositors through the deposit insurance program of the Deposit Insurance and Credit Guarantee Corporation (DICGC), an RBI subsidiary. This insurance program covers cumulative bank deposits of up to Rs 5 lakh held by each depositor of each scheduled bank. The cumulative deposits include fixed deposits as well as the deposits maintained in savings account, recurring deposits and current account. Both interest and principal components of the qualifying deposits are insured under this program.
While corporate FDs do not carry market risk, they are prone to credit risk. Unlike FDs opened with scheduled banks, those investing with corporate FDs are not covered under the deposit insurance program of DICGC. Investors can reduce their credit risk by evaluating corporate bonds on the basis of credit ratings assigned by the credit rating agencies like CRISIL, CARE, ICRA, India Ratings, etc. Just as in the case of corporate bonds, corporate FDs having higher credit ratings carry lower credit risk and vice versa.
Liquidity
Listed bonds can be traded in the secondary markets, which allows their investors the opportunity to sell those bonds before their maturity dates and without incurring any prepayment penalty. However, some bonds may have very low liquidity due to their lower trading volumes in the secondary market.
Banks and NBFCs offer two types of FDs—callable and non-callable FDs. A callable FD allows its depositor to close the FD before its maturity date in lieu of a premature withdrawal penalty. In contrast, non-callable FDs do not allow premature withdrawal under any circumstances. Additionally, tax-saver fixed deposits come with a mandatory lock-in period of 5 years.
Tenure
The tenure of bank FDs usually ranges from 7 days to 10 years, whereas the tenure of bonds can range from 1 year to 40 years. However, as bonds are traded in the stock exchanges, investors can purchase bonds from the secondary market for shorter tenures or for those matching their investment horizons. The availability of longer tenures in listed bonds also allows investors to lock in bonds at attractive yields for longer investment horizons.
Tax Deduction under Section 80C
Tax saving fixed deposits issued by banks and the post office are eligible for deduction under Section 80C of the Income Tax Act, up to a limit of Rs 1.5 lakh per financial year. While the principal amount is eligible for income tax deduction, the interest component is taxed according to the depositor’s tax slab. However, bonds do not qualify for any tax deduction under Section 80C.
Taxation of Returns
The interest income earned from both FDs and bonds is taxable as per the tax slab of the investor. However, the interest income earned from tax-free bonds issued by select PSUs and government agencies is exempt from income tax. While FDs do not offer any scope for capital appreciation, any capital gains earned from bonds, both long term and short term capital gains, are taxable. In case of both listed bonds, capital gains booked after 1 year of investment are considered as long term capital gains and are taxed @ 12.5%. Capital gains booked within 1 year of investing in bonds are considered as short term capital gains and are taxed as per the tax slab of the investor.
