What are Bonds?
Bonds are debt instruments where you lend money to the government or a company. In return, you receive regular interest payments and get your principal back at maturity. Bonds are considered safer than equity but offer lower returns.
Types of Bonds
1. Government Bonds: Issued by the government (G-Secs). Very safe, backed by the government. Lower returns but highest safety.
2. Corporate Bonds: Issued by companies. Higher returns than government bonds but carry credit risk. Rating agencies rate them (AAA, AA, etc.).
3. Debt Mutual Funds: Professional managers invest in a portfolio of bonds. Provides diversification and professional management.
Why Invest in Bonds?
- Stability: Lower volatility compared to equity
- Regular Income: Fixed interest payments provide steady cash flow
- Capital Preservation: Lower risk of losing your principal
- Diversification: Balances equity-heavy portfolios
- Tax Benefits: Indexation benefits for long-term holdings
Tax Implications
Long-Term Capital Gains (>3 years): Taxed at 20% with indexation benefit, which reduces your effective tax rate significantly.
Short-Term Capital Gains (<3 years): Taxed as per your income tax slab.
Indexation adjusts your purchase price for inflation, reducing taxable gains. This makes bonds tax-efficient for long-term investments.
Key Considerations
- Interest Rate Risk: Bond prices fall when interest rates rise
- Credit Risk: Corporate bonds can default - check credit ratings
- Inflation: Returns may not beat inflation, reducing purchasing power
- Liquidity: Some bonds may be less liquid than stocks
- Duration: Longer-term bonds are more sensitive to interest rate changes
Who Should Invest in Bonds?
Bonds are ideal for conservative investors, retirees seeking regular income, or as part of a diversified portfolio. They provide stability and regular returns, making them suitable for short to medium-term goals.