Bonds and fixed deposits are both saving instruments offering a fixed rate of return - both form a part of a diversified portfolio of investments. Indians have traditionally preferred the fixed deposit as an investment option. However, there are some innate differences between the two modes of investment. Let's analyse the differences between fixed deposits and bonds.

Fixed Deposits

• A fixed deposit is an investment instrument in which you deposit your money for a fixed period in return for a fixed rate of return.
• The interest earned on a Fixed Deposit can be received in two ways — as periodic payouts at regular intervals over the chosen tenure (non-cumulative), or as a lump sum at the time of maturity, where the interest is compounded and paid out together with the principal (cumulative).
• The rate of return on the fixed deposit, called the interest, is fixed before the commencement of the fixed deposit. This interest rate remains the same during the fixed deposit tenure, irrespective of the change in the market interest rate.
• You have the flexibility to choose your tenure in the fixed deposit.
• Senior citizens are typically offered an additional interest rate on a fixed deposit.
• Fixed deposits are considered low to moderate-risk, safe modes of investment.
• Early redemption of fixed deposits will result in a penalty.

Investment Bonds in India

• Bonds represent the borrowed capital of companies and entities, whether sovereign or corporate.
• Investment bonds in India can be sovereign bonds (issued by the Government of India) or corporate bonds.
• Bonds have a fixed tenure, i.e., you cannot choose the tenure of the investment.
• Bonds have credit ratings issued by credit rating companies. The higher the rating, the safer and more creditworthy the bond is.
• Bonds pay interest as a return in fixed intervals; this can be quarterly, semi-annual or monthly.
• Bonds are more volatile in that changes in the market interest rates can affect the prices of the bonds. If the market interest rates increase, the bond prices decrease and vice-versa. This means there is scope for capital appreciation/depreciation.
• Bonds can default on payments to bondholders. It is better to buy better rated bonds to avoid a credit default event.
• Bonds have a secondary market and can be bought/sold before maturity. Depending on the bond yield and market interest rates, you can buy a bond at a premium or a discount on its face value.
• Bonds are secured by the underlying assets of the entity.

Analysing Bonds versus Fixed Deposit

• Interest payment frequency and flexibility of tenure: You can choose the tenure you want to invest in a fixed deposit. You can also choose the frequency of interest payments to you. In bonds, both the maturity of the bonds and the frequency of interest payments are pre-determined by the company. Interest payment frequency can be bi-annual or annual, depending on the bond's issuer.
• Premature exits: In the case of a fixed deposit, premature redemption attracts a penalty. In the case of bonds, you can easily exit by selling the bonds in the secondary market where they are listed. While comparing FDs versus bonds, exits are possible in both, but each has its own terms and conditions.
• Rating: Most financial institutions have a rating issued by one or more of the credit rating agencies. In the case of bonds, a rating is mandatory from one of the accredited credit rating agencies before the issue. It is better to remember that the higher the rating, the greater the safety of capital and interest payments and the lower the credit default risk.
• Interest rate risk: In the case of FD Vs Bonds, bond prices are more susceptible to interest rate risk than fixed deposits. This is the risk of the changes in the bond prices with changes in the market interest rates.
• Taxation of Interest income: Both fixed deposit and bond interest are subject to tax. There is a special category of bonds whose interest is tax-exempt. But in most bonds, the interest income is taxable.

Bond Fund versus Fixed Deposit

You can also buy bonds through a bond fund. A bond fund is a portfolio actively managed by a fund manager for interest rate and credit default risks. As a bond fund holds multiple bonds, it helps diversify away from the security-specific risk. There is also the oversight of a fund manager actively managing the bond fund. Bond fund yield/returns can be relatively better compared to holding individual bonds or fixed deposits.

Key Takeaways

Whatever the medium of investment, it is essential that you maintain a diversified portfolio. Both bonds and fixed deposits may form part of your portfolio's liquidity/fixed income-generating part. The allocation to each component depends on your risk-return profile and need for liquidity.

Shriram Unnati Fixed Deposit is accredited with "CARE AAA; Stable” by CARE Ratings; “Crisil AA+/Watch Positive” by CRISIL Ratings
Limited; [ICRA]AA+ (Stable)" by ICRA & "IND AA+/Stable" by India Ratings and Research, offers interest rates up to 8.15%* p.a., including an additional 0.50%* p.a. for senior citizens and 0.05%* p.a. for women depositors, along with flexible investment tenures ranging from 12 to 60 months.