Why are tax-free bonds a better investment opportunity for retail investors?

With the tax-free bonds about to set in motion soon, retail investors have a marvelous future to look forward. These bonds are reported to be issued to raise Rs 40,000 crore this FY by top-notch brands in public sector including Indian Railways Finance Corporation, National Highways Authority of India, and Housing and Urban Development Corporation. With these tax-free bonds, retail investors can make anywhere between 7.3 to 7.5 per cent, depending on the maturity period of 10 to 20 years. 

Investors can invest in more than one company and up to Rs 10 lakh in each issue while still being in the retail category. Investment in the tax-free bonds can be made by retail investors, individual investors, Hindu Undivided Family as well as NRIs, while individuals investing more than Rs 10 lakh are categorised as high networth individuals.

The interest accumulated is non-taxable under Section 10(15)(iv)(h). No tax will be deducted at the source from the interest that is accrued to the holders. The proceeds of these bonds are expected to be invested in various infrastructure projects and this is the reason they are only issued by PSUs. Number crunchers observe these tax-free bonds as long-term investment and predict that more retail investors will be attracted to them because of the volatility in equity markets.

The bonds come as a great relief for investors at the time when banks are cutting deposit rates. And while bank deposits are better in terms of liquidity, tax-free bonds offer better returns, although they have longer maturity period and don‘t come with the flexibility of selling them in the secondary market. But the catch is PSU issued bonds that don’t come with the added risk of non-repayment. Investors will be paid interests annually with the amount directly credited to their bank accounts. This makes it a perfect option for those seeking regular income.

Analysts suggest that risk of re-investment is cut down because of the long-term nature of these bonds. The prices of the bonds and their interest rates are inversely proportional. So, when yields reduce, the prices rise and when prices fall, it goes the other way around. In case the rates are cut down by 100 bps, investors will still get an appreciation of five to seven per cent. With that many lucrative options and benefits associated with it, locking in money in tax-free bonds issued by public sector companies is the way to go for retail investors.