The recent instability in the rupee, the interest rates hikes by the RBI (Reserve Bank of India) and the volatility in the share markets have investors thinking about fixed income options like bonds and debts. Of late, bank fixed deposits have increased their interest rates.
While there are also company fixed deposits to consider as they fetch a higher return than bank FDs, company NCDs are considered safer in comparison.
What are Nonconvertible Debentures?
Before we start, if you are not already aware, NCDs are like bonds. Companies have the option of raising money from the public through debentures, wherein unlike shares, the holder becomes a debtor of the company and not the owner.
These come in two forms: convertible and non-convertible debentures. Convertible debentures can be converted to shares after the certain tenure at the discretion of the owner. NCDs, (which offer higher interest rates) as the name suggests, cannot be turned into equity.
Many NCDs are expected to come this year from companies like Tata Capital Financial Services and DHFL, and here are all the differentiating parameters between a bank FD and NCDs that you can look at to make an informed decision.
Tenure and interest rates
While NCDs are usually issued for a minimum maturity period of 90 days and can go up to 10 years. The higher the tenure, the greater the interest rate offered. Additionally, higher risk companies may offer more than others to lure the investors and you need to watch out for that.
On the other hand, a bank FD tenure ranges between 7 days and 10 years. You have the choice to pick the time period you wish to lock your for and the interest rate does not get higher with the tenure. Ideally, 1-year and 5-year FDs fetch high returns.
While the highest a bank FD can offer you is a little over 7 percent for a 3 to 5-year lock-in period, it could be as high as 9 percent in NCD for the same time.
Note that small finance banks offer interest rates as high as 8 percent for 1 year period. Read: 6 Small Finance Bank FDs With Interest Rates As High As 9%
FD can be opened at any bank, whether public, private or small finance bank or even at the post office.
For NCDs, one needs to have a demat account with a brokerage house. Additionally, these are not available at any given time of the year. Companies launch them as required and for a certain issue period only. (If you wish to, you can purchase them in the secondary market after issue closes).
NCDs come with cumulative or annual payout options. Cumulative method reinvests the interest to pay the bulk at maturity. But, not all come with flexible options. Some bank FDs provide monthly and annual withdrawal options and you can also choose to compound the interest earned.
A fixed deposit can only be withdrawn before maturity on paying a penalty, and this is not allowed on all tenures and varies based on the type of FD.
NCDs can only be withdrawn after it matures, but as they are listed on stock exchanges, you have the option to sell them in the secondary market. In doing so, however, you have the risk of losing on returns if the interest rates increase at the time of sale. (explained below)
Returns from FD as well as NCD are fully taxable to its investors in India. The tax burden will be larger for those that fall under higher income tax brackets.
However, FD investments enjoy a tax exemption benefits to a certain extent under section 80C. NCDs have no such benefit; their earnings from sale in the secondary market or otherwise will be taxed as capital gains.
Another important thing to note is that NCD in demat form do not attract TDS (tax deducted at source) while FD gains beyond Rs 10,000 are taxed at source. You will be required to submit form 15 G/H for a refund.
An FD will fetch the interest rate decided beforehand, while NCD interest rate can gain or drop.
This factor is important if you plan on selling it in the stock market. The price of the bond increases with interest rates fall, fetching a profit (capital gain) when sold in the secondary market and vice versa (capital loss).
In terms of security of the money you invest, FDs are insured up to the extent of Rs 1 lakh under the Deposit Insurance and Credit Guarantee Corporation. Now you should understand the failure of payment from a bank is highly unlikely and will depend on the health of the bank. You can pick a well established bank to make your deposits.
NCD issues are given credit ratings that are not based on the company issuing it and these are subject to revision from the rating agencies. Further, highly rated issues have also failed to make payments in the past.
The choice of the NCD should, therefore, be based on the type. As mentioned before, unsecured NCDs promise higher returns but they are riskier and hold the possibility of default in payment by the issuer.