When people hear the word bond, they immediately think it’s something only finance experts deal with. But in reality, bonds are simply a way for you to lend money to a government or company in exchange for regular interest and the return of your invested amount after a set period.
For someone new to investing, bonds can feel unfamiliar because they don’t work the same way as a savings account or a stock purchase. But understanding a few key basics can make the process of choosing your first bond easy.
This guide will walk you through the essentials – what bonds are and what to consider before putting in your money – so that your first step into bond investing is informed and comfortable.
Understand What a Bond Is
At its core, a bond is a simple agreement: you lend your money to an issuer – which could be the government, a public sector institution, or a private company – and in return, they agree to pay you interest at regular intervals and give back your initial investment (called the principal) at the end of a set period, known as the maturity.
Bonds are issued for different purposes – funding infrastructure projects, expanding business operations, or meeting other financial needs. For you as an investor, the key point is that bonds are structured with clear terms:
- Who is borrowing your money (the issuer)
- For how long (the maturity period)
- At what interest rate (the coupon rate)
- How and when you will be paid (payment schedule)
Once you understand these basics, the rest of the selection process becomes easier, because you’ll know exactly what information to look for before making your decision.
Note: It’s also worth noting that the coupon rate (the fixed interest rate the bond pays) is not the same as the yield (the actual return you earn based on the price you pay for the bond). We have discussed both the concept below with a simple example.
Decide Your Goal
Before you start looking at specific bonds, it’s important to be clear about why you want to invest in one.The type of bond you select, and the features you prioritize, will be determined by your goal.
Some common goals include:
- Regular income: If you want consistent interest payments, you might look for bonds with shorter payment intervals (quarterly or half-yearly).
- Capital preservation: If your focus is on protecting your invested amount, you may prefer bonds from issuers with stronger credit ratings.
- Portfolio diversification: Bonds can add stability to a portfolio that already has equities or other higher-risk investments.
Knowing your goal also helps you decide on the maturity period, the credit rating you’re comfortable with, and whether you should consider tax-free bonds or taxable ones. Without this clarity, you might focus on the numbers without understanding if they truly meet your needs.
Check the Safety (Credit Rating)
Every bond comes with a credit rating given by agencies like CRISIL, ICRA, or CARE. This rating shows how likely the issuer is to pay interest on time and return your principal at maturity.
Here’s how the ratings generally work:
Credit Rating | What does it indicate? |
AAA | Strongest ability to repay, lowest credit risk |
AA+, AA, AA- | Very strong ability to repay, very low credit risk |
A+, A, A- | Good ability to repay, low credit risk |
BBB+, BBB, BBB- | Adequate ability to repay, moderate credit risk |
BB | Moderate risk of default |
B+, B, B- | High risk of default |
C | Very high risk of default |
D | In default or expected to default |
For first-time investors, ratings in the AAA to A range are generally considered more reliable because they indicate stronger repayment capacity. Lower-rated bonds may offer higher interest, but they also come with higher chances of delayed or missed payments. Understanding the rating helps you measure the trade-off between risk and potential return before committing your money.
Note: This is not investment advice. Always review the official documents, offer terms, and risk factors before investing in any bond.
Look at the Interest Rate
The coupon rate is the fixed percentage of your invested amount that the bond will pay you as interest, usually on a quarterly, half-yearly, or yearly basis. For example, if you buy a ₹1,00,000 bond with a 7% annual coupon rate, you’ll receive ₹7,000 each year until the bond matures.
However, the coupon rate is not the only number you should focus on. The yield – which takes into account the price you pay for the bond – can be different from the coupon rate. If you buy a bond at a discount or premium, the yield you actually earn may be higher or lower than the coupon rate.
Now, let’s say you buy a bond for ₹95,000 in the market instead of ₹1,00,000:
- You still receive ₹7,000 each year.
- But since you paid less, your actual return on investment is ₹7,000 ÷ ₹95,000 = 7.37% – this is the yield.
Similarly, if you buy the bond for ₹1,05,000:
- You still get ₹7,000 annually.
- But now your return is ₹7,000 ÷ ₹1,05,000 = 6.67% – a lower yield.
A few things to keep in mind:
- Compare the coupon rate with current market interest rates to see if it aligns with your expectations.
- Higher coupon rates often mean higher risk, so check the bond’s credit rating before deciding.
- Consider your cash flow needs – bonds with frequent interest payouts may suit you if you want regular income.
By understanding both the coupon rate and the yield, you’ll have a clearer picture of what the bond will realistically return to you.
Understand the Maturity Period
The maturity period is the time after which the bond issuer will return the principal amount to the investor.
- Short-term bonds: Up to 3 years
- Medium-term bonds: 3 to 10 years
- Long-term bonds: More than 10 years
Choosing the maturity period should align with financial goals. For instance, saving for a specific expense within three years may be better matched with a bond of a similar term.
Check for Tax Implications
The returns from a bond are influenced not just by its interest rate but also by how the income is taxed. For most bonds, interest earned is added to the investor’s taxable income and taxed according to the applicable income tax slab. This means the actual return after tax could be lower than the stated coupon rate.
Tax Aspect | Details |
Interest Income | • Added to the investor’s total income. • Taxed as per the income tax slab. • Post-tax return can be lower than the coupon rate. |
Tax-Free Bonds | • Usually issued by government-backed entities. • Interest earned is exempt from tax. • Often carry lower coupon rates but can provide better post-tax value for higher income brackets. |
Capital Gains Tax | • Selling a bond before maturity may lead to a gain or loss. • The tax rate depends on the holding period and whether the bond is listed or unlisted. |
Key takeaway: Always consider post-tax returns, not just the headline coupon rate, when comparing bond options.
Conclusion
Selecting the first bond is less about chasing high returns and more about building a strong foundation in fixed-income investing. A thoughtful start by understanding interest income, tax implications, and risk can pave the way for smarter, more confident investment choices in the future. Begin with manageable amounts, observe how bonds perform, and gradually shape a strategy that aligns with personal financial goals.
Disclaimer
This content is for informational purposes only and does not constitute financial, investment, or tax advice. Investors should assess their personal financial situation and consult a qualified advisor before making any investment decisions.
Frequently Asked Questions
How to decide which bond to buy?
To decide which bond to buy first, think about your investment goals, the issuer’s credit rating, maturity period, and coupon rate. This way, you can match the bond’s risk and return with your overall financial plan.
What is the 70/30 rule for stocks and bonds?
The 70/30 rule suggests keeping 70% of your portfolio in stocks for growth and 30% in bonds for stability. You can always adjust this mix based on your age, goals, and comfort with risk.
How to determine which bond is better?
When figuring out which bond might suit you better, compare safety (credit rating), returns (yield), and maturity period with your needs. Also, consider taxes, as they can make a big difference to your final returns.
How will you choose the bond to be satisfied?
To feel confident about your choice, pick a bond that balances safety, returns, and holding period in line with your comfort level. Checking in on your investments from time to time can help keep them on track.
