How to invest 1n bonds: A primer

Until March 31, 2023, long-term capital gains on debt mutual funds were taxed at the rate of 20 per cent after indexation.

- Sudipta Mitu

But now they are taxed on a par with individual bonds: gains from both are taxed at the investor's slab rate from this financial year onward. Due to this development, many investors who in the past preferred debt mutual funds are now gravitating towards bonds.

Advantages of direct investing

One advantage of investing directly in bonds is that investors can earn a higher rate of return. In a debt mutual fund, the investor has to pay an expense ratio. This lowers the net return (gross return of the portfolio minus the expense ratio) that the investor earns. In an individual bond, he does not have to pay any fee. In a debt mutual fund, fund managers also keep cash and cash equivalents to meet redemption requests. This also lowers the returns from debt mutual funds.

Another advantage of direct investing is that the investor exercises complete control over which bonds to go for. He can choose a bond based on the return he wants to earn and the amount of risk he is prepared to take. In a debt mutual fund, the fund manager picks the bonds for the portfolio.

Three key risks

Investors need to be cognizant of the three key risks of investing in bonds: credit, interest rate, and duration risk. Credit risk is the risk of the borrower (in this case, the company whose bonds the investor has purchased) failing to pay the interest, or failing to return the principal, on time.