In the next few months, it is going to rain Tax Free bonds to the tune of 40000 crores. Know what is in it for you–
a. What are tax free bonds?
Tax free bonds are debt instruments issues by Public Sector Enterprises , who are authorised to issue bonds to customers to raise capital for their expenses / working capital?
b. What is the duration of these bonds?
These come with duration of 10, 15 and 20 years. That is if you buy a bond with a maturity of 20 years, you will get your capital after 20 years.
c. What is the rate of interest?
These come with interest rates as desired by the companies and it is expected to be in the range of 7.25 to 7.35% per annum.
d. What is the credit risk? or risk to the capital?
These are bonds issued by public sector enterprises and have crisil rating of AAA which means they are very stable. These are backed by the government of India as the Government is the majority stake holder in these companies.
e. Who can apply?
Any resident individual or HUF and corporates can apply.
f. What is the minimum amount?
The minimum amount would be Rs 5000. Normally these bond come with a face value of RS 1000 each and this can vary based on the issue.
g This should be bought in physical form or Demat form?
One has the option to buy in any form they desire to buy. However there is a difference one should know.
In physical form, an investor will continue to get the interest annually. However this cannot be sold in between. Capital will be returned on Maturity based on duration.
h. Can I surrender this or sell this before Maturity?
This cannot be surrendered before maturity. However if one wants to sell before maturity, this can be sold in the BSE (Bombay Stock Exchange) trading platform, through an authorised broker.
IN order to do this, you must have a demat account.
i. How will the interest be paid?
The interest will be paid to the bank account opted by the customer in the application through electronic transfer.
j. Is this a good time to buy these bonds? Who should buy these bonds.
This is an ideal investment vehicle for investors, who want safety and assured returns without loss of capital. Many of these investors invest in FDs in bank.
With the interest rate coming down as the RBI is reducing the interest rates, there is a reinvestment risk.
Reinvestment risk, is that when you reinvest the FDs you do not get the same interest as the previous period but lower than that. This is called reinvestment risk
The tax free bonds have the same rate of interest and hence it has no capital risk or reinvestment risk.
Especially retired persons, who seek, regular cash flows with least risk can opt for this.
Also others as a diversification in asset allocation can have this in their portfolio.
k. What will be the rate of these bonds if I were to sell this in between maturity say two or three years later?
The bonds will be traded on the stock exchange and the bond prices will vary from the face value. Depending upon the interest rate outlook, the bond prices may be higher or lower.
For example, the bonds issued in 2013 are trading at a premium of 20% ie. a 1000 face value bond is now available at 1200. So an investor who has bought this two years back, would have got 2×8.5% plus 20% if he sells it today.
l. Is there capital gains tax, if sold later?
In the example given above, on 20% a 10% capital gains is charges if sold after one year. ie you pay 2% tax. However if you sell before one year, the entire gains is added to your income and taxed as per your income slab.
g. What is the scope for appreciation or capital gains in the short term?
As long as the interest rates are downward biased the bond prices will be higher. with the next one to two years, we are expecting more rate cuts there is a high probability of capital gains.
However if the interest rates were to raise, it is possible that the bond prices may be sold even below face value of RS 1000.
It is recommended for the customer cited above that this could be a good option and a very good alternative to FD at the least for the next 2 to 3 years.
For details do contact me
|9 years||5 years||3|
|amount invested in 2006||100000|
|cost of inflation index||1.973025048|
|fund value today||216621.5946|
|tax @ 20%||3863.817947|
|post tax return||112757.7766|
|annual absolute return||12.50%|
. Are you the one who is looking for safe havens and not the ones to take risk and lose capital.
The first option that comes to your mind is FD. There not so good news for investors in FD.
The Biggest PSU Bank SBI has reduced the interest rates in FDs recently and this has been followed by banks such as Punjab National Bank and others are following soon.
Why this is happening?
- RBI has redefined liquidity and banks are now borrowing through term repo rates and the interest on this is coming down.
- The credit growth is not taking off. Companies are borrowing outside the banking system through commercial papers which are cheaper.
- RBI is expected to reduce interest rates as the inflation is softening and this reduction may take place early 2015.
- There is reinvestment risk, which means when you reinvest the FD or renew the FD, you are likely to get interest lower than what you are getting currently.
If you are the one who is renewing the FDs every year and staying invested in FDs at least for a period of 3 years, read on.
You are likely to get 6- 26% extra tax free return over FD returns. See the summary table below
There are options available which protect capital and can give you better tax efficient returns,
The market ie the sensex is at around 26 k and going by the valuation it is around 20 times PE and is much lower than the high valuations we had in 2007.
The prospects for the markets to go by in valuations are high due to the following reasons.
- The currently the earning of the sensex companies are at 1585 and is expected to grow at 15% CAGR and is projected at 1800 for FY 17.
- This being the case, at current valuations, market could be at least 20% higher and when the valuations catch up, we could see the market at higher value
- Also the inflation has peaked and is showing signs of slowing down.
- The GDP is projected to improve
- With the fiscal consolidation taking place, the interest rates are likely to come down.
- This will do good for debt funds, which has moderate duration which can benefit out of the lower yield curve.
Therefore considering the time frame and the requirement,
- The lumpsum can be invested in Debt funds, Like dual advantage funds, MIPs etc for which a minimum investment period of 3 years is recommended.
- This period is required a. to get indexation benefit and get better tax efficient return b. There is no exit load applicable beyond the 3 year period.
- These vehicles invest in both, debt and equity, debt being 75-80% and equity component being 20-25%.
- By doing this, generally capital is protected and there is a probability of getting higher returns.
- With the market outlook looking positive and debt market expected to do well with anticipated interest rate reduction, the probability of getting higher returns are quite high.
I give below the year on year return if one had invested in reliane MIP, a debt fund.
Year of investment 1 yr return 2 yr 3 yr 4 yr 5 fyr
Oct 2009 11,615% 12,8% 25.73 41,54 57.98
Oct 2010 1.06 12.65 19.22 33.05
Oct 2011 2.2 17.96 40.55
Oct 2012 4.8 25.64
Oct 2013 19
As you will see the return vary for a one year period but is farily stable for a 3 yearperiod and no capital loss has happen
The 5 years return on Rs 10000, if invested in 2009 is 15,798 (57.98%) and . Using the indexation, which is adjusting the cost of purchase, 161.24 and hene no tax is applicable. If you had invested in FD at 9% interest, you would got, 13,150.
Consider three year return.s
2009 – The amount of Rs 10000 becomes, 12,573 and the cost using indexation is 12,216 and you pay tax on Rs 357 @ 20% . which is Rs 72. Total tax free return is 12,500. Compare this with 11,890
2010 – 11,920 Vs 11890
2011 – 14,055 is the return and cost is 11900 and you pay tax of 430 and net return is 13,625.
|tax free return|
|3yr||4 yr||5 yr|
|MIP||FD||%GAINS OVER FD||MIP||FD||%GAINS OVER FD||MIP||FD||%GAINS OVER FD|
If you are renewing FDs year on year, you can consider these types of fund, which for a period of more than three years can offer capital protection and can offer good return in comparison to FDs in the long run.
Please do contact me for choosing the right vehicle for investment.
If you have funds and planning to park in FD. Read below.
FD in banks give a return currently around 8.5% to 9% for a one year maturity and you may get 0.25 % to 0.5% in case if it is invested in a senior citizen name.
Assuming you are a tax payer in the 30% bracket, and assuming the int is 9.5% , you still get a return of 6.65% post tax.
Compare this with debt funds. You can get a double digit return in one year and most importantly the taxation is different if it is more than one year ie one year and one day, you pay only 10% tax as capital gains and hence if you get a return of 10% your tax free return will be 8.9% ie you get 30% more tax free returns.
These are invested in safe returns and hence safety is not an issue.
One of the members had done this and the investment has grown to 11.4% (annualised) in 90 days
In case you have any doubts, pick up the phone and call me.
Thanks & Regards
v s varadharajan