Tax Free Bonds vs Bank FDs

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FINANCIAL marketplace is witnessing a battle going on in the debt segment with issuers trying to influence investors to park their money with them. On one side, issuers are raising the pitch with tax-free bonds, and on the other side, various banks are matching this with aggressive offers on their deposits to ensure that investors do not desert these for the long-term bonds. This is a good opportunity for investors to ensure that they are able to make the most out of the situation and ensure that their goals are properly met.

A little bit of homework will be useful and here is a look at how investors can actually make their decisions.

Interest rates:

One of the major attractions for investors is obviously the interest rates that are offered on various instruments.

The first thing that many investors look for is clearly the final amount that they would earn on the investment. The natural thing to look for is obviously a higher rate because this would ensure that the earnings would be higher at the end of the day. However, while considering the interest rate, its nature also needs to be considered. The taxfree bonds have a rate this is actually post tax returns, so if there has to be proper comparison then the rates that are being compared would have to be brought on to the same level.

The interest rate on fixed deposits would be taxable in nature and hence the final rate would depend on the income-tax slab that the individual will fall under. This is the reason why each individual will have to ensure that the rate that they actually face is used in the workings so that the right decision can be actually made. Another condition related to the interest rates is that the investor should consider is the actual figure that they would earn and not just the stated figure. In this sense, there would be a different amount that could be earned if the representation is not done properly related to the compounding or the time period for payment and hence, the detail about the manner in which the interest rate is actually calculated would have to be undertaken.

Time period:

 A very crucial aspect of the entire decision making process is the time period of the investment. The tax-free bonds are long-term instruments where the period of investment could stretch up to 20 years, while fixed deposits can be very short-term in nature. In this sense, there has to be a different way of analysing the instruments.

When it comes to the longterm instrument, if there is a higher rate of interest being offered for the entire period then this would be quite attractive as compared to a higher rate for shorter time duration.

There is no reinvestment risk in the longer-term instrument and this would have to be considered when the time period of the various instruments is being looked at.

Window for investment:

The time period for making the investment is also crucial because the investor will realise that the opportunity will not be open for a very long time. When it comes to the tax-free bonds, there is a specific time period for which the investment can be made in a particular issue but even within this if the issue is oversubscribed then the manner of allocation of the bonds has to be considered as to whether this will be proportionate or on a first come first serve basis. The other thing is that even special deposit schemes that offer a higher rate of interest would be open only for a fixed time period and hence here too the investor might have to act quickly to lock in their returns.

Happy Investing!!

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