Bonds vs Fixed Deposits: Which is the Better Investment Choice?

What Are Bonds?

Bonds are considered a low-risk investment because they yield a fixed income. Companies and governments issue bonds to borrow money from individual or institutional investors instead of borrowing from a bank or other institutional lender in order to execute a new project, buy new equipment, or expand their operations.

Bonds can have different maturity periods, payout periods, and interest payouts. They can also have a different face value, which is the rupee value of the bond as stated by the issuer and the amount the investor will receive when the bond matures.

Most Indian bonds have a face value of Rs. 1000.

What Are Fixed Deposits?

Fixed deposits are also known as term deposits and are offered by banks and non-banking financial institutions (NBFCs) instead of companies or governments. In return for an investor’s lump sum, the bank pays interest at a certain rate. When the FD matures, i.e., at the end of its tenure, the investor receives the principal plus compound interest.

Unlike market-led investments, FD returns do not fluctuate over time, making them ideal for investors looking to save money and earn a steady income.

Some FDs also offer good returns, depending on the issuer and deposit type. Nonetheless, these returns are always lower than the returns possible from high-risk investments like equity. FDs, therefore, are ideal for investors who:

Bonds vs Fixed Deposits: A Head-to-head Comparison

Both bonds and FDs are fixed-income debt instruments that represent a loan contract between lenders and borrowers. These similarities notwithstanding, there are many differences between these instruments. Let’s explore them in detail.

Issuer

A bond can be issued by a public or private company, a government, or a municipality when they want to borrow money from investors. In return, they make a legally-binding promise to pay interest on the principal and return the principal when the bond matures. In contrast, FDs in India are always issued by banks and NBFCs.

Safety/Risk

Although FDs and bonds are considered safe fixed-income investments, they are not completely risk-free.

Bond risk can be moderate or high if the issuing company is not financially stable or if a credit rating agency deems that their default risk is high. Bond risk also depends on the physical assets backing them.

Usually, bank FDs are low-risk because they don’t depend on market conditions to determine investor returns. That said, like bonds, FDs also carry some risk if the bank is not financially stable.

Tenure

Some banks and NBFCs offer FDs for ultra-short tenures or terms of 7-14 days. The maximum FD tenure is 10 years. Tax-saver term deposits have a lock-in period of 5 years, meaning the investor cannot withdraw the money before this period.

The tenure of bonds depends on the issuer. For example, the Government of India issues bonds for 5 to 40 years. Companies may issue bonds for shorter or longer periods based on their purpose and target amount.

Liquidity

FD liquidity depends largely on tenure since it determines when you can recover your principal. Thus, if you open an FD for 7 days, you can recover the principal very quickly, which makes your funds highly liquid. However, longer-tenure FDs mean that the principal is tied up for longer, reducing liquidity.

If you require sudden liquidity, you can prematurely withdraw your FD. However, you will lose out on future interest and may also have to pay the penalty to the bank.

Bonds that are frequently traded or traded at high volumes on a stock exchange will have stronger liquidity, meaning you can easily sell them for cash. Other bonds are usually less liquid, so you may find it harder to sell them.

Interest Rates

The interest rate on low-tenure FDs is always lower than the interest on higher-tenure FDs. This is because the higher interest is the “price” the issuer pays in return for using your money for a longer period.

Bond interest rates depend on the issuer. A stable company that’s unlikely to default will generally offer lower rates because your risk is low, while unstable companies will offer higher rates to compensate for your increased risk of potential loss. Just like an FD, a bond with higher tenor will come with a higher interest rate. This is called the term premium.

Frequently Asked Questions