In recent times, tax-free bonds have caught investors’ fancy and rightly so. In case, you have not invested in these bonds, the forthcoming issues might be a chance you do not want to miss, especially considering the interest rates being offered (HUDCO 9.01% and NTPC 8.91% for individual investors investing less than Rs. 10 lakhs).
Still wondering why you should invest in tax-free bonds?
Well, tax free bonds are bonds issued by government controlled corporations carrying a fixed rate of interest, payable annually.
The reason they are called “tax-free bonds” is that the interest received is not taxable in the hands of the investor.
Now, consider the interest on these bonds – the proposed issues are offering interest rates more than or equivalent to a pre-tax interest paid by most banks on a fixed deposit. To be on the same footing, banks would have to offer interest rates in excess of 13%*!!! Thus, tax-free bonds are akin to an FD but without any tax implications on the interest income…
Since tax-free bonds are mostly issued by government-backed companies, the credit risk or risk of non-repayment is very low.
Wait, there is more to tax free bonds than just the interest…
Apart from the interest component, investors stand to gain from these even in terms of price appreciation. Here is how:
Tax-free bonds are listed on the stock exchange. Although, the bonds are redeemed at par at the end of their tenure, their price can fluctuate depending on the interest rate cycle of the economy. Bond prices and interest rates are inversely related and therefore, if the interest rates decrease, you can expect the price of the bond to increase. The longer the tenure of the bond, the greater the fluctuation expected. Given the current economic scenario, there is a high possibility that you could take home handsome returns. If nothing else, you will get annual interest payments and your principle back at the end of the tenure.
So what’s the catch?
Although these bonds are listed on the stock exchange, the liquidity of such bonds is not as high as that of stocks. The demand for such bonds is likely to increase once the interest rates begin to come down. Accordingly, one would have to be patient for such bonds to yield handsome returns.
Tax-free bonds are suitable for investors looking for a steady source of income annually and can afford to lock-in their capital for the long term. These bonds are also a very tempting proposition for people belonging to the high income tax bracket.
So, why delay!
* for investors falling in the 30% tax bracket