Bonds vs Fixed Deposits: Understanding the Key Differences

What Are Bonds?

In India, both bonds and fixed deposits (FDs) are popular fixed-income instruments. While they share the common goal of providing stable returns, the two differ significantly in structure, liquidity, taxation, and risk exposure.

For investors seeking predictable income and capital protection, understanding the differences between bonds and fixed deposits can help in making informed financial decisions. This article explores their key characteristics, comparing them across several parameters such as interest rate, risk, taxation, and accessibility.

Bonds are debt instruments issued by entities like the government, public sector units, or corporations to raise funds. When investors purchase a bond, they essentially lend money to the issuer for a fixed tenure in exchange for periodic interest payments (known as coupons) and repayment of the principal amount at maturity.

Bonds come in various forms, such as:

• Government Bonds (G-Secs): Issued by the RBI on behalf of the Government of India.

• Corporate Bonds: Issued by private or public companies.

• Tax-Free Bonds: Certain public sector bonds with tax-exempt interest.

• Perpetual Bonds: Bonds without a fixed maturity date.

The interest rate offered depends on the issuer’s credit rating, market interest rates, and tenure of the bond.

What Are Fixed Deposits (FDs)?

Fixed Deposits, offered by banks and non-banking financial companies (NBFCs), allow individuals to deposit a lump sum for a fixed period at a predetermined interest rate. Upon maturity, investors receive the principal plus accrued interest.

FDs are considered among the most traditional investment products in India due to:

• Low risk and guaranteed returns

• Flexible tenure options (from 7 days to 10 years)

• Coverage under DICGC insurance (up to ₹5 lakh per depositor per bank)

Interest Rates: Bonds vs FDs

The interest rate on bonds may be fixed or floating, depending on the type of bond. Government bonds and corporate bonds often offer rates linked to prevailing market yields or benchmark rates like the RBI repo rate.

In contrast, FDs offer fixed interest rates for the entire tenure, providing certainty but limited flexibility if market rates rise.

For example, a government bond might offer 7.5% with periodic coupon payments, while a bank FD might offer 6.5% for a similar duration.

Taxation: FD vs Bonds

Fixed Deposits:

• Interest earned on FDs is fully taxable as per the investor’s income tax slab.

• Tax is deducted at source (TDS) if annual interest exceeds ₹40,000 (₹50,000 for senior citizens).

Bonds:

• Interest income from most bonds is also taxable as per income slab.

• Capital gains tax applies if the bond is sold before maturity.

• Long-term capital gains (LTCG): 10% without indexation (if held >12 months).

• Short-term capital gains (STCG): Taxed as per income slab.

Certain bonds, such as Tax-Free Bonds issued by PSUs, offer tax-exempt interest.

Risk and Safety Considerations

While FDs are generally considered safer due to bank backing and deposit insurance, bonds carry varying levels of credit risk, depending on the issuer’s financial strength.

For instance:

• Government bonds are virtually risk-free.

• Corporate bonds carry credit risk but may offer higher returns to compensate.

Another aspect is interest rate risk—the market price of bonds fluctuates with changing interest rates, which does not affect FDs since they are held till maturity.

Liquidity and Accessibility

Bonds can be traded on exchanges, providing liquidity before maturity, whereas FDs are not tradable and can only be prematurely withdrawn (usually with a penalty).

For investors seeking flexibility, listed bonds offer a secondary market exit option, while FDs suit those preferring fixed tenure commitments without market volatility.

Which Is Better: Bonds or FDs?

There is no universal answer, as both instruments serve different objectives:

• FDs suit investors prioritizing capital safety, simplicity, and assured returns.

• Bonds appeal to those seeking higher potential returns, regular income, and portfolio diversification, while being aware of associated risks.

An informed investor may consider balancing both in a portfolio depending on their risk appetite, investment horizon, and income needs.

Example: Comparing Returns

Illustration:

If an investor deposits ₹1,00,000 in an FD at 6.5% for 5 years, they would receive approximately ₹1,37,000 on maturity.

Alternatively, a bond with an 8% coupon may yield ₹1,46,000 over the same period, subject to credit quality and market factors.

This is only an illustrative comparison and not an investment recommendation.

Conclusion

Both bonds and fixed deposits play vital roles in an investor’s financial planning. FDs offer stability and simplicity, while bonds provide market-linked returns, diversification, and tradability.

Investors should carefully evaluate issuer credibility, interest rate conditions, and taxation implications before making a decision.

The right choice depends on one’s risk tolerance, liquidity needs, and long-term goals.

Frequently Asked Questions (FAQs)

1. What is the main difference between bonds and fixed deposits?

Bonds are tradable debt instruments that may offer fixed or floating interest, while FDs are non-tradable deposits offering fixed interest until maturity.

2. Are bonds riskier than FDs?

Bonds may carry credit and market risk depending on the issuer, whereas FDs are typically safer and backed by banks, with insurance up to ₹5 lakh per depositor per bank.

3. How are bonds taxed compared to FDs?

Both bond and FD interest income are taxable as per income tax slab. However, bond investors may also face capital gains tax if they sell bonds before maturity.

4. Can I withdraw my money before maturity in both?

Bonds can often be sold in the secondary market, while FDs can be prematurely withdrawn with penalty charges.

5. Which is better for long-term savings?

FDs are ideal for conservative investors seeking fixed returns, while bonds can suit those comfortable with moderate risk and aiming for higher potential income.

Disclaimer

This blog is intended solely for educational and informational purposes. The bonds and securities mentioned herein are illustrative examples and should not be construed as investment advice or personal recommendations. BondScanner, as a SEBI-registered Online Bond Platform Provider (OBPP), does not provide personalized investment advice through this content.

Readers are advised to independently evaluate investment options and seek professional guidance before making financial decisions. Investments in bonds and other securities are subject to market risks, including the possible loss of principal. Please read all offer documents and risk disclosures carefully before investing.