Why you should invest in TAXFREE BONDSTaurus Capital AdvisorsJanuary, 2013
Do you invest in Fixed Deposits • If you invest in Fixed Deposits, it is primarily because of any/ or all of the following reasons • Certainty of returns – a ﬁxed deposit has a ﬁxed rate of return • No risk to the capital – Banks (especially PSU banks) are here to stay forever • Regular income – Interest income is received at regular intervals • Ease of operations – You can go to your bank’s branch and they open your ﬁxed deposit Fixed Deposits are a very good investment to protect your capital and earn decent return
What are Real Returns? • I would like to explain this with an example • Mr. X, made a ﬁxed deposit for a ﬁxed rate of 9.0% for 3 years • Which means he would get 9% every year • This income is taxable as per the tax slab of Mr. X, assuming he is in the highest tax bracket (i.e. 30.9%) • After tax return for this ﬁxed deposit is then – 6.22% • In other words Rs.10,000 in ﬁxed deposit gives him Rs. 622 in hand • Inﬂation – an indicator of increase in cost of living • Currently inﬂation in India is around 8-9% (average of last 3 years) • Real Returns = Nominal Returns – Inﬂation • In this case Mr. X, has a negative real returns • In simple words Mr. X is earning less then his increase in cost of living, and in some years his capital would start eroding Are Fixed Deposits generating wealth?
So, how to increase Real Return? • As you can guess it yourself, there are two ways to do that • Choose an investment which has higher rate of return, and/or • Investment where tax impact is lesser • Asset classes like Equity, Gold and Property can generate higher returns, but they are riskier too. There could be a risk to the capital too. • Then how do we improve returns or reduce tax burden, and still remain in the same asset class of Fixed Income • Fixed Deposits are a type of ﬁxed income instruments Choosing a better ﬁxed income product can help increase returns or reduce tax burden
Fixed Income Options1 Fixed Deposits with banks or housing ﬁnance companies like HDFC Annual or quarterly interest payment, instead of cumulative Return ★★★ Tax ★★ Liquidity ★★★★2 Fixed Maturity Plans (FMPs) by mutual fund houses Reduce tax burden by taking beneﬁt of indexation Return ★★★★ Tax ★★★★★ Liquidity ★★3 Tax Free Bonds by PSU entities Annual interest payment, which would be Tax free Return ★★★★★ Tax ★★★★★ Liquidity ★★★★
Introduction to Tax Free Bonds • Tax free bonds are offered by government companies • Money raised is invested in infrastructure development in the country • Interest earned on such bonds is Tax Free • Current & upcoming offerings are given below Issuer Issue Start Issue End Coupon Coupon (10 Years) (15 Years) India Infrastructure Ongoing 11-Jan-13 7.69% 7.86% Finance Co. Ltd. HUDCO 9-Jan-13 22-Jan-13 7.84% 8.01% Indian Railway Finance 21-Jan-13 29-Jan-13 7.68% 7.84% Co.
Some numbers Before Tax After TaxFixed Deposits 8.75% to 9.65% 6.00% to 6.70%FMPs 8.50% to 8.75% 8.50% to 8.75%1(Double indexation)Tax Free Bonds 11.10%2 7.69%1. Negligible tax impact due to double indexation, which is the effect of inﬂation2. Is the pre-tax yield, assuming the individual is in the highest tax bracket
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