Bonds: All Newbies Need to Know

Bonds, though not as flashy as stocks, have steadily carved a niche for themselves in the investment landscape. They offer stability, predictable returns, and form an essential part of a well-diversified portfolio. But with numerous types and terminologies, they can seem daunting. Let’s break it down.

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Bonds 101: The Basics

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Bonds are essentially IOUs where the borrower, typically a government or corporation, promises to pay back the amount borrowed at the end of a specified period, along with regular interest payments. This interest, termed as a coupon, is the primary way investors earn returns on their bond investments.

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When you invest in a bond, the total amount you put in is called the bond price. The returns you earn from a bond, expressed as a percentage of this bond price, is known as the bond yield.

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Government Bonds

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One of the most secure investment avenues, government bonds are issued by both Central and State Governments. These bonds or Government securities (G-Secs) are primarily long-term investment instruments, with tenures ranging from 5 to 40 years.

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Types of Government Bonds Include:

• Fixed-rate bonds: Offer a constant interest rate throughout their tenure, ensuring predictable returns.

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• Floating Rate Bonds (FRBs): Their interest rates vary periodically based on predefined intervals.

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• Sovereign Gold Bonds (SGBs): A smart alternative to physical gold, allowing investment in gold without the hassles of storage. The bonus? Tax-free interest.

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• Inflation-Indexed Bonds: These bonds adjust both the principal and interest earned against inflation, ensuring your returns aren’t eaten away by rising prices.

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• Zero-Coupon Bonds: These don’t offer regular interest. Instead, they’re issued at a discount to their face value and redeemed at face value.

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Why Consider Government Bonds?

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• Sovereign Guarantee: A promise of assured returns and principal repayment.

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• Protection Against Inflation: Certain bonds like Inflation-Indexed Bonds safeguard your investment against rising prices.

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• Steady Income: Regular semi-annual interest payments.

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However, remember, the interest rate might be relatively lower than some other investment instruments, and long-term bonds can lose relevance with high inflation.

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Corporate and Other Bonds

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Apart from the government, many private and public sector companies issue bonds, known as corporate bonds, to meet their capital needs. They often offer better returns than traditional savings accounts.

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Some Other Notable Bonds Include:

• Convertible Bonds: Can be converted into equity shares of the issuing company.

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• RBI Bonds: A safe offering with an attractive 7.75% interest rate, open for individual investors.

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• T-Bills vs Bonds: Government securities with less than a year maturity are termed T-bills, while those over a year are called bonds.

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Residual Maturity is key

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While the tenure of a bond might seem like the most crucial factor, residual maturity – the remaining time for a bond’s maturity – is often more pertinent. For instance, a bond issued for 10 years will have a residual maturity of 8 years after two years from its issuance.

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Focusing on residual maturity, rather than just the bond’s overall tenure, helps investors make informed decisions, especially when considering long-term instruments like Public Provident Fund (PPF) PPF or Sukanya Samriddhi Yojana (SSY), the two tax-efficient government savings schemes that offer good interest rates.

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Bonds with Benefits

With a myriad of options available, bonds can cater to various investment needs, from risk-averse individuals to those seeking regular income or protection against inflation. However, as with any investment, it’s crucial to understand your financial goals, risk appetite, and ensure a diversified portfolio.

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