BT Insight: RBI floating rate bonds available at 7.15%; should you invest?

BT Insight: RBI floating rate bonds available at 7.15%; should you invest?

If you invest in fixed rate bond at lower rate and the rate increases after some time you incur notional loss. One of the most unique advantages with this bond is that it will not carry an interest rate risk like the fixed rate bonds

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RBI floating rate bonds have been one of the most sought after investment options for people looking for safest regular income option. The government suddenly closed this scheme on May 28 when the interest rate on it was 7.75 per cent. However, soon the government re-launched it with lower interest rate of 7.15 per cent from July 1 this year. This bond gives regular payout with half yearly interval on January 1 and July 1. We tell you whether it makes sense for you to invest in this bond at the reduced interest rate.

Who can invest in the bond?

This bond is not for NRIs as only resident individuals or HUF can invest in the bonds. This bond can be held in joint capacity by individuals. There is no age limit for this bond. You can also invest in this bond on behalf of a minor as father, mother or legal guardian.

How floating rate mechanism works?

Unlike other bonds, it does not have a fixed interest rate but a floating rate of interest. The interest on the bond has been linked to the rate of National Savings Certificate (NSC), a small savings instrument by the government. This bond will pay 0.35 per cent higher than the NSC interest rate. The interest rates on small saving schemes are reviewed and often revised on quarterly basis. The current rate of 6.8 per cent that became effective on April 1 has not been changed for the next quarter July-September 2020. So based on changes in the rate of NSC, the interest rate on RBI bond will keep changing.

Well placed to gain from future interest increase

If you invest in fixed rate bond at lower rate and the rate increases after some time you incur notional loss. One of the most unique advantages with this bond is that it will not carry an interest rate risk like the fixed rate bonds. This becomes important especially when you are contemplating to invest at a time when interest rates are at record low level. Therefore the chances of the interest rate going significantly up in medium term are much higher than the interest rate falling further by significant amount.

No tax benefit

This bond does not give any tax benefit either on the amount that you invest or the return that it generates. As a result, interest income will be added to your total income and you will have to pay income tax based on your tax slab. TDS is also deducted on interest income if it crosses the threshold.

No mid-term liquidity

This bond is meant for only long-term investment as it has a tenure of seven years, although it offers lower lock-in period for various categories of senior citizens. The lock-in period for people in the age group of 60-70 years is six years, five years for those above 70-80 years and four years for people above 80 years.

Who should invest in this bond?

This is one of the very few options which offers the best combination of higher interest rate and has no limit on investment amount. "As the issuer is the government of India, and due to the sovereign nature of these bonds, credit risk is considerably low. Investors with low-risk appetite and a reasonable rate of return can opt for these bonds. Safety and return of capital at maturity are what investors should be looking at in current uncertain times," says Vikas Khaitan, Co-founder and Partner, Fintrust Advisors.

Most of the big banks are offering the best interest rate of around 5.5 per cent for general public and around 6.30 per cent for senior citizens. Therefore, despite the interest rate reduction it still offers one of the highest interest rates in safest fixed income investment category.

One of the best options for conservative investors

For conservative investors below the age of 60 years, this bond is among very few options which give high return. On top of it, there is no limit on the investment amount. People who have gone for retirement in late 40s or early 50s cannot invest in PMVVY and very few would be eligible for SCSS. In such a case this bond is one of the best options for them. "For investors, not in the high-income tax bracket, this is a good investment option. However, it is not suitable for those in the higher tax brackets (more than 30 per cent)" says Khaitan of Fintrust Advisors.

Good option for senior citizens with higher corpus

When it comes to senior citizens looking for regular income product the preferred option should be SCSS and PMVVY. However, SCSS and PMVVY have the maximum limit of only Rs 15 lakh. Therefore, senior citizens, who may have higher investible corpus, can consider the RBI bond after exhausting the limit of SCSS and PMVVY. "Senior citizens should invest in this product as they look forward to regular income flow for their healthcare and maintenance expenses. Also they have very less risk appetite; hence this product may be suitable for their needs," says Amit Jain, Co-founder & CEO, Ashika Wealth Advisors.

When you can have limited exposure

If you are looking for investment option with higher growth over long-term then it may not be the best option. "Anyone who is looking for growth should not invest in these kinds of products. For asset growth they should invest either in equity-related mutual funds or hybrid mutual funds to generate better risk adjusted returns," says Jain of Ashika Wealth Advisors. People who have higher risk appetite and can invest in equities with long-term horizon can only invest partially in this bond as part of the their debt investment allocation.

Using it in combination of equity MFs

People who do not want regular income but want their investment to grow may find this bond less attractive as it pays regular interest and does not offer any accumulation. The payout carries a re-investment risk as it will be difficult to find out a matching option to reinvest.

If you are fine with equity investment you use a combination of this bond and equity MFs. You can keep your capital safe with RBI bonds and invest the regular payout in equity MFs in a staggered manner by way of investing it first in debt fund then transferring it to equity funds each month through a systematic transfer plan.

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