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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.

10010 views  3 Apr 2018

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:

  1. 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.
  2. 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.
  3. Cumulative Deposits: These are issued by both Public and Private companies but give interest alongwith principle at the time of maturity.
  4. 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:

  1. Default Risk: A company may default from paying the bondholders if its financial health detoriates.
  2. 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.
  3. 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.