Compared to bank deposits or small savings, non-convertible debentures, liquid funds, tax-free bonds and company fixed deposits offer higher returns, albeit with some risks.
Non-convertible debentures: Companies issue NCDs to raise long-term funds. These debentures cannot be converted into shares or equities and lenders offer a higher rate of return compared to convertible debentures. Non-convertible debentures are of two types —secured and non-secured. The secured ones are backed by assets, wherein if the company is unable to fulfil its obligations, the assets are liquidated to repay the investors.
So, secured non-convertible debentures pay lower coupons than non-secured ones. Companies issuing non-convertible debentures offer higher rates because they carry default risk compared to bank or postal deposits. Investing in NCDs makes sense for those in the 10% to 20% tax brackets, as those in the lowest tax bracket can get post tax returns around 7% for a 120-month tenure. One should invest in non-convertible debentures only if he can hold them till maturity.
Liquid funds: Investors can also look at liquid funds offered by asset management companies for short-term investment for up to a year. The fund will yield marginally higher returns than bank deposits. Moreover, they are as liquid as time and demand deposits as the market regulator has allowed fund houses to offer instant redemption facility of up to Rs.50,000. In fact, one aspect where bank deposits scored over liquid funds or any other money market funds was same day redemption.
Now that has been taken care and investors can manage cash flows better. At the time of investing in debt funds, investors must analyse the credit rating of the bonds in which the fund house invests. While debt funds are not rated, their safety can be analysed from the portfolio they invest in. Fund managers may sometimes take higher position in bonds with lower rating for higher returns.
Tax-free bonds: Tax-free bonds were issued by state-owned companies such as NHAI, IRFC, HUDCO till March 2016. However, investors can now buy these bonds from the secondary market and can earn up to 2% more than bank fixed deposits after tax. Tax-free bonds are an attractive long-term investment as there is no deduction of tax at source from the interest that accrues to bondholders, irrespective of the interest amount or status of the investor.
These bonds score over fixed deposits or other debt investment as investors do not have to pay tax on the returns. Before investing in tax-free bonds, one must look at the issue size as it may impact liquidity. For instance, NHAI’s Rs 10,000-crore bond issue has the highest traded volume on bourses.
Company fixed deposits: Even by investing in company fixed deposits of top-rated firms, investors can earn up to 150 basis points more than bank fixed deposits. However, investors must exercise utmost caution because while bank deposits provide security for investment up to Rs . lakh, this is not the case with corporate fixed deposits.
The tenure of company deposits ranges from one to seven years and one can earn compounding interest by reinvesting the principal amount along with the interest earned. Investors can get direct ECS credit facility for interest payments or advance interest warrants for the year. However, unless one needs income regularly, they should prefer cumulative schemes to regular income options since the interest earned gets reinvested at the same coupon rate, resulting in better yields.