Why you should invest in Fixed Income Instruments
In this episode of Dhan ki Baat, Devansh Mehta, Senior Manager, IIFL, discusses investment in Fixed Income Instruments as an asset class.
Bonding with Bonds
Bonds or Debt Investment may still seem to be an uncommon investment option in the mind of many investors. The usual investment avenue of the majority has been equity, real estate, gold and mutual funds, but bonds are also an excellent investment option.
Bonds helps in diversifying your capital, it adds stability to the overall portfolio. Majority of bonds help getting regular income in the form of interest.
It is a great way to beat inflation as they protect principle and offer regular interest income.
Above illustration clearly shows that savings in Bank’s Saving A/c is nothing less than destruction of wealth, one needs to invest in right avenues.
Fixed Income Investments : A Brief
One thing that comes to our mind on hearing fixed income investments is Bank Fixed Deposits, but there is much to it such as bonds, company deposits, debentures, etc.
Fixed Income investment is important in one’s portfolio as it helps to maintain stability and also helps earning consistent flows. Investors usually have prefered bank fixed deposits and equity for investments. Although, fixed deposits do provide stability and regular interest, one can choose from other options for additional returns over bank deposits.
Many corporates, public and private issue bonds and deposits, for raise funds, which are used for their expansion or operational needs.
These have varied fundamental features such as secured or unsecured, different interest frequency, maturity and embedded features, which are well mentioned in the bond factsheet.
Let us understand a few of the popular options:
- Tax Free Bonds: Usually issued by PSUs that offer tax free interest income, i.e. the interest earned on the investment of these bonds is tax free.
- Bonds/Debentures/Deposits: A broader category that is issued by both Private and PSU companies, which offer fixed interest income either monthly, quarterly or annually.
- Cumulative Deposits: These are issued by both Public and Private companies but give interest alongwith principle at the time of maturity.
- Zero-Coupon Bonds: These are also known as deep discount bonds, they are issued at deep discount to the face value of the bond, which on maturing gives the investor the face value.
However, the bond investments too carry some risks:
- Default Risk: A company may default from paying the bondholders if its financial health detoriates.
- Liquidity Risk: Exiting from corporate deposits/bonds may be difficult if not listed. However, even if listed, some of the bonds may find less volumes on the exchange.
- Interest Rate Risk: Interest rate risk can be explained in two ways: reinvestment risk and price risk.
- Reinvestment risk: Investor faces risk of investing the proceeds from the investment at lower rate than the existing rate of interest.
- Price risk: Bond yields and prices are inversely related, thus in rising interest rate scenario, the price of existing investment reduces. Thus, if the investor wishes to exit before maturity, he may receive less value than invested.
Mr. Devansh Mehta has over 9 years of experience in Mutual Fund Research, Investment Advisory and Products. He joined IIFL in May 2017 as Senior Investment Advisor - Senior Manager for Mutual Funds and Products. Prior to IIFL, he worked with Axis Bank and Axis Capital Ltd. (erstwhile Enam Securities Pvt. Ltd.). He holds a PGDM - Finance from FLAME University (Pune).
Ask an Expert
How should I to buy bonds/deposits or similar instruments?
The bonds/deposits are issued or announced by companies for investors and one can subscribe and get allotment for the same. In addition, one can also buy them from exchanges in case of listed securities.
What is price risk?
Bond yields and prices are inversely related i.e. if the yield of the bond rises, prices fall and vice versa. Yields of the bonds are based on the expectation of investors and based on the yields of similar bonds.
What are the main parameters I should consider before investing?
You should first understand their goals and needs before investing. Further, you should look at the issuer, maturity, yield, interest payment frequency, embedded call/put options, coupon of the bond and minimum investment.
How should I assess default risks associated with investing in bonds?
Majority of the bonds/deposits are rated by agency depending on the financial health and future prospects. In addition, you should also look into the embedded features and options of the bonds before investing. These will help you in understanding the risk level of the bonds.
Is there a chance to lose money in bonds due to reasons other than issuer default?
If you hold the bond till maturity, then NO if there is no issuer issue. But if you redeem before maturity, then there are chances of loss of capital if yields are higher than the investment yield.
What is the difference between coupon and yield?
Coupon is the actual rate at which one receives interest on the face value of the bond, while yield is the effective rate of return on the market value of the bond. If the market price and face value are same, then coupon and yield are same.
Are the credit ratings updated post issuances?
Yes, the credit rating agencies, who have rated the issuer or a particular investment offering, keep regular track of them and communicate the same in the market.