“Bonds can be silver bullets in personal finance as bonds give fixed returns”.
Investing in debt instruments can be a safer and smarter option! Then you must be thinking of Bonds… but got a little distracted by an advertisement that was alluring you towards mutual funds?
Here is an article to solve your dilemma and help you to understand difference between Bonds and Debt Mutual Funds
Bonds:
Bonds are debt instruments issued by entities like corporates or government organizations for a predefined duration(maturity period). Here, the investor is the creditor and the issuer is the borrower. On lending money to the issuer, the investor is entitled to receive fixed returns every year from the issuer. On maturity of the Bonds, the principal amount along with any outstanding interest return is paid to the investor. The Bond returns(interest payments) are unaffected by market conditions. This makes the bond a fixed income instrument.
Debt Mutual Funds:
A mutual fund is an investment program where a pool of money(created by investors) is collected and the fund manager strategically diversifies the investment of the money collected across various investment options like equity or bonds. The investor has the option to choose the investment category: if the investor chooses to invest in debt then such a mutual fund is called a debt mutual fund. The fund manager in such a mutual fund invests in debt instruments. These debt instruments are nothing but bonds only. Returns are either reinvested by the fund manager or the investor can opt to sell his instrument at the current market price. If an investor can sell at a premium then he can make a profit else he may incur losses.
Differences between Debt Mutual Funds and Bonds:
Fixed Income:
Bonds provide investors with fixed returns as the bond issuer is the borrower and owes money to the bond owner. Even in case the company goes bankrupt, creditors are paid on their investment.
In the case of mutual funds, there are no fixed returns as the returns depend on the market price of the underlying bonds at the time the investor wishes to sell his funds.
Returns :
As of February 2020, the top 10 debt mutual funds gave average annual returns of around 7.88% for a 3-year investment horizon.
In comparison to this, a typical Bond IPO with 3 years investment horizon and AA rating gave around 9.7% effective annual yield.
As a rule of thumb, Bonds and Debentures give much better returns than most Debt Mutual Funds in the market.
Liquidity:
The liquidity of bonds is relatively tougher than the liquidity of mutual funds.
In mutual funds, the fund manager and his team will take care of liquifying your investment and the process is very quick and well organized.
Risk:
Mutual funds won’t assure any kind of returns whereas bonds return principal amount on maturity and fixed payouts at a predefined regular period of time. The issuer owes money even in case of insolvency. Hence risk in bonds is very low compared to the risk in debt mutual funds.
Investment expenses:
Mutual funds are managed by fund managers hence they do charge management fees whereas bonds are direct investments hence there are no investment expenses.
Tax benefits:
Gains that you earn either from mutual funds or bonds are taxable under the tax slab applicable to the investor.
Portfolio Management:
In the case of mutual funds, the fund manager manages a portfolio of collated investment and the investor doesn’t have the option to buy/sell the underlying bonds present his portfolio. Also, fund managers keep changing from time to time and this also impacts the fund returns.
In direct bond investment, the investor has all the freedom to buy/sell individual bonds and hence have full control of his/ her portfolio.
Accessibility:
Mutual funds are very popular investment instruments hence mutual funds are traceable either way: online and offline.
Bonds are underlying assets for debt mutual funds; unfortunately, these are not easily accessible online and most of the trading happens over the counter (OTC).
Institutional investors manage to buy and sell bonds over the counter through their network. But for retail investors, bonds are not easily accessible and investable. Lack of accessibility to bonds has been blocking retail investors in leveraging the bond market. This gap is being encashed by debt mutual funds and the investors pay management fees to these mutual funds and don’t even get fixed returns.. GoldenPi aggregates AAA to A-rated bonds on its innovative online platform so that retail investors can compare bonds and invest in them easily and reap the benefits of truly fixed returns.
