FD vs Bonds: FD or Bonds? Where can you get higher returns while saving tax? Understand the full calculation..

FD vs. Bonds: If you keep a significant portion of your savings in Fixed Deposits (FDs), this information is relevant to you. Even today, most people in India consider FDs the safest investment. The reason is clear: the returns are predetermined, and the risk of losing capital is minimal. However, many investors are now turning towards bonds, primarily due to the potential for better tax planning and higher returns.

Before investing, however, it is important to understand that FDs and bonds differ not only in interest rates but also in tax implications and withdrawal rules.

How is interest taxed?

Interest earned on an FD is added to your total income and taxed according to your income tax slab. For instance, if you earn 7% interest on an FD and fall into the 30% tax bracket, your actual return after tax deduction will be significantly lower.

Interest (or 'coupon') earned on bonds is taxed in a similar manner. Whether it is a government bond or a corporate bond, the interest is taxed based on your income tax slab. Therefore, making a decision based solely on the interest rate is not advisable.

Where do bonds have the edge?

This is where bonds can outperform FDs. With FDs, you earn only interest. However, with listed bonds, you can benefit from capital appreciation—an increase in the bond's price—in addition to the interest income.

If you purchase a bond when interest rates are high and rates subsequently fall, the bond's price may rise. If you sell it after a year, the profit is subject to Long-Term Capital Gains (LTCG) tax at a rate of just 12.5%. For many investors, this rate is significantly lower than their income tax slab rate. Consequently, the post-tax return on bonds often turns out to be better than that of FDs.

Where can you access funds quickly when needed?

You can break an FD prematurely, but banks levy a penalty. Often, the interest rate applicable is also reduced. On the other hand, listed bonds can be sold on the stock exchange at market price. There is no penalty imposed by the issuer for this. However, the price may fluctuate based on market conditions.

FD Interest Rates of 10 Major Banks

Bank                  General Customers    Senior Citizens
SBI                        3.05% - 6.45%               3.55% - 7.05%
HDFC Bank            2.75% - 6.50%            3.25% - 7.00%
ICICI Bank             2.75% - 6.50%             3.25% - 7.10%
Axis Bank               3.00% - 6.45%             3.50% - 7.20%
Kotak Mahindra Bank    2.75% - 6.70%    3.25% - 7.20%
Punjab National Bank    3.00% - 6.60%    3.50% - 7.10%
Bank of Baroda     3.50% - 6.45%             4.00% - 7.00%
Union Bank of India    2.75% - 6.60%     3.00% - 6.85%
IDFC FIRST Bank    3.50% - 7.40%       4.00% - 7.90%
YES Bank             3.25% - 7.00%         3.75% - 7.75%

Where should you invest?

If your goal is to build an emergency fund or you seek guaranteed returns without risk, then an FD is a better option. However, if you are a long-term investor looking for better post-tax returns, you might also consider highly-rated government or corporate bonds.

Many financial advisors believe that you do not necessarily have to choose just one of the two. Maintain a Fixed Deposit (FD) for your emergency fund and allocate a portion of your long-term fixed-income portfolio to bonds. This will help diversify risk and potentially improve your post-tax returns.