₹1 Lakh in NCDs vs FDs Over 3 Years — Return Calculation

Understanding NCDs: What is a Corporate Bond in India?

Before we compare numbers, let’s quickly understand the two options. First, you need to know debt/exit-ncd-before-maturity-india">what is xirr-corporate-bond-portfolio">corporate bond in India, because a Non-Convertible Debenture (NCD) is a type of corporate bond. When you buy an NCD, you are lending money to a company. In return, the company promises to pay you a fixed rate of interest for a specific period. At the end of that period, called the tenure, the company returns your original money.

The ‘non-convertible’ part is simple. It means your bond cannot be converted into shares or equity of the company. It will always remain a debt instrument. These NCDs are issued by companies to raise funds for their business needs.

Key features of NCDs include:

• Fixed Returns: You know exactly how much interest you will earn.
• Higher Interest Rates: They usually offer higher interest rates than bank Fixed Deposits to attract investors.
• Credit Rating: Every NCD is rated by agencies like CRISIL or ICRA. A rating like ‘AAA’ is considered the safest, while a ‘B’ rating is risky. Higher risk usually means a higher interest rate.
• Tradability: NCDs are listed on stock exchanges like the BSE and NSE, so you can sell them before maturity. However, finding a buyer can sometimes be difficult.

The Familiar Fixed Deposit (FD)

A Fixed Deposit is something most of us know well. You give your money to a bank for a fixed period. The bank pays you a fixed interest rate. It is one of the most popular and trusted fd-net-worth-growth">savings-schemes/scss-maximum-investment-limit">investment options in India.

FDs are known for their safety. In India, deposits in scheduled banks are insured by the dicgc-protection">Deposit Insurance and Credit Guarantee Corporation (DICGC), an RBI subsidiary, for up to 5 lakh rupees per person, per bank. This makes them extremely low-risk.

The 3-Year Return Calculation: NCD vs. FD

Let's get to the main point. You have 1,00,000 rupees to invest for three years. We will compare a typical bank FD with a well-rated NCD.

For this calculation, we will make a few assumptions:

1. Investment Amount: 1,00,000 rupees
2. Tenure: 3 years
3. FD Interest Rate: 7% per year, compounded quarterly.
4. NCD Interest Rate: 9% per year, compounded annually (we'll use the cumulative option for a fair comparison).

Here is how the numbers stack up:

As you can see, with an interest rate just 2% higher, the NCD earns you over 6,000 rupees more than the FD over three years. The power of a higher interest rate is clear. But returns are only one part of the story. You must also consider the risks involved.

Beyond Returns: Weighing Risk and Taxes

A higher return almost always comes with higher risk. This is the most important difference between NCDs and FDs.

Risk Factor

An FD is extremely safe. The bank's health is a factor, but the DICGC insurance up to 5 lakh rupees gives you a strong safety net. It is almost a risk-free investment for most people.

An NCD carries yield-spread-vs-credit-spread-corporate-bonds">credit risk, also known as default risk. This is the risk that the company you lent money to will fail to pay the interest or return your principal. If the company goes bankrupt, you could lose your entire investment. This is why you must check the credit rating before investing in an NCD. An 'AAA' rated NCD from a strong company is much safer than an unrated NCD from a new company.

Tax Treatment

The tax rules for both are quite similar. The interest you earn from both FDs and NCDs is considered 'Income from Other Sources'. It is added to your total annual income and taxed at your personal dividend-tax-india">income tax slab rate. If you are in the 30% tax bracket, you will pay 30% tax on the interest earned.

There is one small difference. For FDs, banks deduct 80c/invested-80c-tds-didnt-reduce">TDS (Tax Deducted at Source) if your interest income exceeds 40,000 rupees in a financial year. For NCDs held in a ipos/ipo-application-rejected-reasons-fix">demat account, there is no TDS. However, this does not mean the income is tax-free. You are still responsible for declaring this income in your tax return and paying the appropriate tax.

Liquidity

Liquidity means how easily you can convert your investment back into cash. You can break an FD before its maturity date, but the bank will charge a penalty, usually by lowering the interest rate. With NCDs, you can sell them on the stock exchange. However, the market for corporate bonds can have low volume-analysis/volume-analysis-fando-traders-india">trading volumes. This means you might not find a buyer immediately, or you might have to sell at a lower price than you want.

How to Choose Between an NCD and an FD

The decision depends entirely on your financial goals and your comfort with risk.

Think about your risk appetite. Are you someone who sleeps better at night knowing your money is completely safe, even if it earns a little less? Or are you willing to do some research and take a calculated risk for a better return?

You should choose a Fixed Deposit if:

• You are a conservative investor or a beginner.
• Safety is your number one priority.
• You want guaranteed returns with no surprises.
• Your investment amount is within the 5 lakh rupees DICGC insurance limit.

You can consider a Non-Convertible Debenture if:

• You have a moderate risk appetite.
• You are looking for higher returns than FDs and are willing to accept the associated risk.
• You understand how to read a credit rating and research a company's financial health. You can find information on corporate bonds on the SEBI website.
• You want to diversify your debt investments beyond banks.

Ultimately, there is no single right answer. For some, the peace of mind from an FD is worth the lower return. For others, the extra thousands of rupees from an NCD is a welcome reward for taking a measured risk. A balanced approach could even involve putting some money in FDs for safety and some in high-rated NCDs for better returns.