FD vs Bonds vs Stock Market

A Fixed Deposit is a financial instrument offered through banks that provides the investors a higher rate of interest whereas a Bond is a financial instrument that represents loans made by investors to borrowers. Stock is an investment that represents an ownership share in the company and the place where the shares listed by the companies are traded in the Stock Market.

In a Fixed Deposit, people invest money for a fixed period at a predetermined rate of interest and the interest rate varies from one financial institution to another. The financial institution returns the amount invested at the end of the tenure which is known as the maturity period. The bank uses this money to lend to other borrowers and charges them interest. A fixed deposit is often known as a time/term deposit. It ranges from a very short term period of 7-14 days up to a long-term period of 10 years. There are several types of fixed deposits like standard term deposits, senior citizen fixed deposits, tax-saving fixed deposits, recurring deposits, etc.

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It is you who decides whether to reinvest or receive the interest periodically in your bank account. If you do not need a regular stream of income, cumulative FDs are for you, it pays you the interest at maturity and is reinvested every year whereas non-cumulative FDs pay you interest at fixed intervals and this will give you a regular stream of income. Depending upon your needs, you could choose to receive the interest payments (monthly, annually, or quarterly ).

Long term fixed deposits are good for a working person as it offers greater liquidity and higher returns. You can even go up to 4 lakhs of loan against FD using the long-term FDs.

The formula to calculate interest on fixed deposit is:

Interest on fixed deposit = Amount invested x Rate of interest x (Duration/12 months)

PROS

• The interest on fixed deposits is guaranteed.

• FD comes with a fixed tenure which ensures the safety of your money.

• It offers higher fixed deposit interest rates to senior citizens.

CONS

• Even though FD returns are guaranteed, the returns are lower as compared to other investments.

• If the depositors withdraw money before the date of maturity, it leads to a penalty.

• FDs are not always liquid and cannot be converted into cash easily.

A bond means loaning money to the issuer for a fixed period of time and the value of the bond is repaid at the end of the period. Bonds are commonly used by governments, companies, municipalities, and corporations to borrow money. It is inversely correlated with interest rates, i.e., when the rate falls, bond prices go up and vice-versa. Since bonds pay fixed interest rate coupons to debtholders, it is known as a fixed-income instrument. Bonds have maturity dates and the principal amount should be paid back in full. A bond has two features, credit quality and time to maturity. There are varieties of bonds like zero-coupon bonds, convertible bonds, puttable bonds, etc. A bond’s price changes on a daily basis and as usual the price depends upon the supply and demand, the price changes also depend upon the changes in interest rates in the economy.

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When companies or other entities need to raise funds for maintaining or starting a new project, they issue bonds directly to the investors. The issuer issues a bond which includes the interest payments that will be made, loan details, and the maturity date. The coupon rate is the interest rate that determines the payment.

A bond’s initial price is usually the face value per individual bond. The actual market price depends upon the coupon rate, the credit quality of the issuer, etc. When the bond matures, it is its face value that will be paid back to the borrower. Bonds can be repurchased and new bonds can be reissued at a lower cost.

Are bonds a good investment?

Bonds can provide higher and fixed income as compared to money market funds or bank instruments and hence it is a good investment option. It provides tax benefits. Bonds are useful if you are looking to save money for a long term purpose and it has a reputation for safety.

Looking at the current scenario, bonds are a good investment. It protects against deflation. Even at low-interest rates, bonds play a role in a portfolio.

PROS

• As compared to stocks, bond prices fluctuate less.

• Earn profit by reselling the bond at a higher price.

• Can receive income through interest payments.

CONS

• As compared to stocks, it has lower returns.

• It suffers from price fluctuations as the interest rates go up and down.

• Bonds with high face value will be less liquid as the buyers will be smaller.

The stock market is a collection of markets that includes buying and selling of stocks through the stock exchange or OTC marketplaces. Stock exchange and stock market are interchangeably used. The former is a subset or part of the latter. New York Stock Exchange and Chicago Board Options Exchange are two of the leading stock exchanges in the US, this and other exchanges together form the stock market in the US.

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Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) are the two leading stock exchange markets of India. BSE is the oldest stock exchange in Asia and is located in Mumbai whereas NSE is the youngest stock exchange in India and its first exchange was to provide a modern and latest electronic trading system.

The stock market ensures fair pricing and transparency in transactions as several market participants join together to buy and sell shares. It provides a secure environment.

Stock markets can act as primary and secondary markets. As a primary market, through the process of initial public offerings (IPO), the companies issue and sell their shares to the public. This helps the companies to raise capital from the investors. To sell these shares, a company needs a market place and it is provided by the stock market. As a secondary market, the investors buy and sell securities that they already own. Stock exchange earns a fee for every trade happening in the secondary market.

PROS

• Placing your finances in the stock market helps you grow. Many companies pay dividends to investors which increases the return on investment.

• You can become a minority owner by investing in a stock market.

• Since the number of participants is huge, it assures a fair price.

CONS

• When you invest in a stock market, the higher the return, the higher the risk of losing money.

• Investing in the stock market is a time-consuming and complex task.

• Whenever you decide to buy/sell shares, you will need a certain amount (brokerage fees) for paying the fees to the broker.

As you can see from the above-mentioned information, there are advantages and disadvantages to FD, bonds, and the stock market. FD interest rates are higher than bonds and bonds offer more tax benefits. As compared to stocks, bonds are more beneficial as it involves less risk. At the end of the day, it is you who decides what and where to invest, have a clear idea about all the options, and choose what's best for you.

“In the longer run, it's not just how much money you make that will determine your future prosperity. It's how much of that money you put to work by saving it and investing it.”

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Author - Fiza Fathima

Content Writer at Escribo