The difference between fixed deposits and bonds helps to understand which investment option is better to invest.
The main difference between bonds and fixed deposits is that a bond is a fixed-income security, while a fixed deposit is a type of deposit. In the complicated and detailed landscape of financial planning, fixed income securities play a crucial role, offering investors stability to counter the inherent volatility in equity markets.
These investment options are important for capital preservation, diversified portfolios, and helping investors predict their future income properly. For investors around the world, fixed deposits and bonds are two of the most embraced fixed-income options. When it comes to investing safely, these two options come into the picture — most people invest their money in these two ways for mental peace. But while both investment options are safe, they work fundamentally in different ways and serve different financial goals for individuals or corporations.
This comprehensive guide will help you understand the difference between the two. After reading this blog, you don’t have to read any other blog or any such content about bond vs fixed deposit.
Understanding Fixed Deposits in Layman’s Terms
In the world of investment, fixed deposits have been one of the most important conservative investment options for centuries. Now that we are in a new age, it’s essential to revisit traditional investment options. In the finance world, there is a very famous saying: History repeats itself, meaning whatever happened in the past repeats itself. Let’s start the discussion.
What Are Fixed Deposits?
A fixed deposit is a financial instrument offered by banks and non-bank financial companies (NBFCs) that allows individuals to invest a lump sum amount for a predetermined period and at a predetermined interest rate. Unlike a savings account, which offers a low interest rate and high liquidity, fixed deposits lock your funds for a specific period. This period can vary from 7 days to as long as 10 years. FDs offer flexibility to investors with different financial goals. The interest rate varies between 5% to 8.85% per annum, depending on the tenure and the investor’s age.
How Fixed Deposits Work
If you invest your money in a fixed deposit, you lend your money to banks and non-bank financial companies (NBFCs). In return, the bank promises to pay investors a fixed interest rate and return the principal at maturity. The interest is paid periodically or reinvested to benefit from compounding returns.
For example, if you invest $100,000 in a fixed deposit with an interest rate of 8%, you will get $8,000 per year. In three years you will get $24,000 total interest. But in a cumulative FD, you will get $25,900 in three years. That’s why people say compounding is the eighth wonder of the world.
Key Characteristics of Fixed Deposits
Fixed deposits have some main characteristics that make them very popular among conservative investors.
- Fixed Interest Rate: In a fixed deposit, you will get a fixed interest rate. This is one of the main characteristics of FDs.
- Guaranteed Returns: You will get guaranteed returns in a fixed deposit. This gives corporations and investors confidence to invest money in fixed deposits.
- Flexible Tenures: FDs are highly adaptable in terms of their investment duration. The tenure can start from 7 days to as long as 10 years. This flexibility allows investors to align their deposit period with their financial objectives.
- Loan Against FD Facility: A notable characteristic of FDs is that you can take a loan against the FD. In difficult times, investors have an option to tackle problems in a better way.
- Compounding Option: Investors have the choice to get interest periodically, such as monthly or quarterly, or to opt for a cumulative FD. In a cumulative FD, the interest is reinvested in the principal, allowing investors to benefit from the compounding effect, where interest is earned on interest.
Types of Fixed Deposits
- Standard Term Deposit: This is the most common fixed deposit — you deposit a fixed amount for a specific tenure.
- Senior Citizens Fixed Deposit: For senior citizens, fixed deposits offer a higher interest rate for individuals aged 60 years and above.
- Flexi Fixed Deposit: Allows partial withdrawals without breaking the entire deposit. In some FDs, if you withdraw money, you will get a penalty.
- Recurring Deposit: From your bank account, on a monthly or quarterly basis, a fixed amount will automatically be deducted and converted to FDs.
- Tax Savings FDs: On these FDs, investors get a tax benefit with a lock-in period of 5 years or 10 years.
What Is a Bond?
A bond is a fixed-income security and financial instrument. Governments, corporations, and institutions raise money through bonds without diluting any equity. In return, they promise investors to repay interest periodically and the face value (principal) at maturity. A bond is a predictable income financial instrument that gives investors some predictability about the future.
Types of Bonds
- Government-issued: Issued by central and state governments for administration and infrastructure expenses. Example: Treasury Bills, Sovereign Gold Bonds.
- Corporations: Issued by corporations to fund business operations.
- Municipal: Issued by local municipal governments.
- Zero Coupon: Issued at a discounted price on face value, with no periodic interest. At maturity, you receive the face value.
- Convertible: The face value of the bond is converted into the company’s shares.
Both are fixed-income instruments that have a rightful place in an investor’s portfolio. Understanding both is important. If you want more from us, please comment on the blog.