Include tax-free bonds in your investment portfolio

As the tax filing season is nearing, you must be anxious to know how you can save as much as possible from your interest income. When we talk of tax-free investments, what else than tax-free bonds could we think of. Including tax-free bonds in your investment portfolio is one of the ideal ways to cut tax and save money as the interest earned on these bonds are exempt from income tax.

Salient features of tax-free bonds: • Interest from these bonds is not subject to income tax• There is no lock-in period • Post-tax yield on tax-free bonds are higher than normal Bank FDs• Issued by government-owned companies. So they are unlikely to default• Rated AA or higher• Listed on NSE & BSE and can be easily traded in hence they have assured liquidity  • Can be held in Demat form which would help investors check their investments regularly

Tax-free bonds have attracted immense attention in the recent years especially among investors who are in the higher tax bracket of 20% and 30%. If we look at traditional Bank FDs, it is difficult for them to offer more than 9% interest in the long term., whereas, tax-free bonds have given 7.5-8% tax free returns for 10-20 year term. Apart from offering higher post-tax returns, these investment options also offer good scope of capital appreciation.

Who can invest?a) Retail individual investorsb) Qualified institutional buyersc) Corporatesd) High net-worth investors

Crucial aspects to check before investing in tax-free bonds:

a. Rating: Different agencies such as CARE, ICRA and Brickwork Rating India assign ratings to the companies issuing tax-free bonds. Most of the time, investors tend to invest in the bonds which are rated AAA. But, according to experts, even AA or higher companies can also a prudent option.

b. Size of the issue: The larger the size of the issue, the higher the probability of good volume after listing. You can also get an idea about the possible volume by looking at the existing volumes of previous issues of the companies.

c. Tenure: Yet another important area to be looked upon is the right tenure of the issue. There are bonds which have 10-15 year term. However, experts suggest that investors should ideally go for longer duration bonds, say 20 year term. Since there are no put or call options for these bonds, you must decide the time periods for which you want to remain invested.

People who have surplus money that can be locked in for 10-20 years and who seek steady source of income annually can park their money in tax-free bonds. Some of your fixed income asset allocation should be towards these bonds. So why not explore this ideal option now when many companies are in process of launching their issues in the coming few months.    

- Vatsal Shah

The author is the Senior Business Analyst at Sushil Financial.