Last Updated on February 2, 2024 by ethinos
In recent years, the stock market has emerged as a preferred investment avenue for many retail investors in India. While this is certainly a positive development, many people in the younger generation of investors tend to overlook the importance of stabler investment options like debt securities. Bonds, in particular, can be extremely beneficial for all types of investors. Before you write them off entirely, why not take some time to understand the benefits of investing in bonds? That way, you can make a smart decision about diversifying your portfolio to include debt-oriented assets like bonds.
What is a Bond?
A bond is a debt security that is issued by various entities like central or state governments, banks, financial institutions, public companies and other corporate entities. When you invest in a bond, the purchase price you pay is effectively the sum that the bond issuer borrows from you. The funds thus raised can be used to further the business or other objectives of the issuing entity.
In exchange for the amount borrowed from investors, bond issuers pay interest on the face value of the bond at periodic intervals. In your typical bond, the interest rate is fixed and known at the time of purchase itself. At the end of the bond’s lifetime, the bond issuer repays the principal or the face value of the bond to the investor.
Since this functions like a loan for the entities that issue bonds, these assets are considered to be debt instruments.
Also Read: The Benefits of Investing in Stocks
The Top Benefits of Investing in Bonds
Now that you have a preliminary idea of what bonds are, you may be considering investing in them. To make a smarter investment choice, it is always a good idea to take an in-depth look at the various advantages of investing in bonds. They include the following:
- Guaranteed Returns
One of the most attractive benefits of investing in bonds is that the returns are typically guaranteed. When you invest in market-linked assets like stocks, the returns, if any, depend entirely on how the market performs. However, in the case of bonds, the returns are mostly assured and known in advance.
For example, if you have purchased a government bond with a face value of Rs. 10 lakhs and a coupon rate of 5%, you can be sure that you will receive Rs. 50,000 each year till maturity. Since these coupon payments are predetermined, it becomes easy to budget your expenses.
- Capital Preservation
One of the many advantages of bonds is that they make it easy to protect your capital from being eroded over time. While the primary goal of investing may be to grow your capital, it is equally important to preserve the capital you currently have.
This is particularly true for risk-averse people and for investors who have no financial cushion. So, instead of putting all your capital into high-risk assets, you can choose to include bonds in your portfolio to preserve some of your capital. This will act as a financial safety net for you and your loved ones in case of any financial contingencies.
Also Read: Capital Gain Bonds (54EC) Explained
- Steady Stream of Income
While long-term profits may be one goal of investing, it is not the only reason to invest your money. You may also want to secure an additional source of income to make it easier to manage your expenses. Alternatively, if you are approaching the age of retirement, you may want to set up an alternate source of income to replace your salary.
This is where the benefits of investing in bonds become relevant. These debt securities offer stable periodic income in the form of coupon payments. By purchasing bonds with attractive coupon rates, you can enjoy a steady stream of income easily.
- Low Initial Investment
Bonds in India are issued at extremely affordable investments. You can find these debt securities issued at face values as low as Rs. 1,000. While this may be too low a value if you want to earn a reasonable amount of interest, it can still be beneficial for investors who do not have a large lump sum amount saved up.
For example, you could save Rs. 1 lakh over a few months and begin investing in bonds. Over time, as you accumulate more capital, you can expand your debt portfolio. All the while, the income benefits of the bonds you have invested in will continue to add up.
- Favourable Risk-Reward Ratio
Another advantage of investing in bonds is that you can improve your portfolio returns without significantly increasing the overall risk. In other words, adding bonds to your portfolio makes the risk-reward ratio more favourable.
This can be particularly useful if you are in a position where you cannot afford to take on huge investment risks, but still want to earn money on your investments. It can also be useful if you are approaching retirement or if you wish to build a secure base of investments before moving on to riskier options.
- Portfolio Diversification
Portfolio diversification is perhaps one of the most important benefits of investing in bonds. At the macro level, you can diversify across different classes like equity and debt. However, even within the category of bonds, you can choose from different options to spread the risk. There are various types of bonds available for investors in India.
Take a look at the most common types of bonds and what they each entail:
- Government Bonds: These bonds are issued by central and state government entities, and they carry extremely low risk since they are backed by the government’s sovereign guarantee.
- Corporate Bonds: These bonds are issued by corporate entities. While they carry relatively higher risks than government bonds, they also offer higher interest.
- Fixed Rate Bonds: The interest rate or coupon rate in these bonds is fixed, so you are aware of the income that you will earn during the bond’s lifetime.
- Floating Rate Bonds: The coupon rates on these bonds are linked to the market interest rates. As the benchmark interest fluctuates, so do floating coupon rates.
- Zero Coupon Bonds: These bonds do not offer any coupon or interest payments. Instead, they are issued at a discount and redeemed at par value.
- Inflation-Indexed Bonds: The coupon rates in these bonds are linked to inflation indices like the consumer price index (or CPI) or wholesale price index (or WPI), making them a hedge against inflation.
- Tax Savings
You can also get the benefits of tax savings by investing in specific government-approved bonds. The maximum amount of deduction under section 80CCF of the Income Tax Act, 1961 is Rs. 20,000. This is over and above the tax benefits u/s 80C and other provisions.
Conclusion
To tap into the advantages of bonds outlined above, all you need to do is find the right category of bonds and start investing in them. Even if you are an aggressive investor who prefers high-risk assets in order to earn potentially high returns, investing in bonds must feature in your investment plan.
By including bonds in your asset portfolio, you can achieve the goal of capital preservation and even set up a reliable source of additional or alternate income. You can also leverage the other advantages of investing in bonds, like portfolio diversification and tax savings.
