SIP Vs Bonds Explained

The Capital Market stands true to its name. It really is a market just like a real - physical or online one, providing you with a wide range of products. On the one hand, it offers Mutual Fund S.I.P.s that are dynamic in their risks and returns, meaning they might be high risk, high return, low risk and low returns or moderate risk and moderate return. On the other hand, it also provides instruments that are virtually free from risk but at the same time offer just enough returns to save your money from losing its value to inflation over years such as bonds and debentures. In this article, we shall be discussing the difference between Mutual Fund S.I.P.s and Bonds.

What Is S.I.P.?

A Systematic Investment Plan (S.I.P.) is a method of investing your money wherein you keep investing a fixed amount of money in an investment scheme over a period of investment mandate time systematically. By ‘systematically’, we mean investing regularly at a fixed interval of time. In today’s market, S.I.P. is usually used to refer to Mutual Fund Investments.

Mutual Fund Investments are instruments of collective investments wherein a large number of retail investors pool in small amounts of investments to create a large fund corpus. This corpus is used to invest in a portfolio containing a large number of securities - equities to earn higher returns, debt securities to earn some fixed income, derivatives to make profits from the foreign exchange etc. Of course, this is just a general description. There are, however, objective-specific mutual funds too that invest specifically in a single class of capital market or money market securities depending on the goals of the investors the mutual fund is trying to cater to.

What Are Bonds?

Bonds, unlike Mutual Funds, are fixed-income debt securities. What that means is the money you put in bonds is not treated as an investment, rather is looked at as a loan. Just like a loan, in bonds also you earn a fixed return in the form of interest on top of the capital you lend. The returns do not depend on the borrower’s profit or loss, you earn the pre-determined interest on time, hence it is called a fixed-income security.

Every bond has a face value. The return on bonds can be given in various ways. One structure of return is when the bond is issued and simple instalments towards the repayment of capital plus the interest at regular intervals until maturity are determined. Another way of earning on bonds is that the bonds are issued at face value and redeemed on maturity at face value, while instalments of interest payment at regular intervals until maturity (called bond tokens) are pre-determined. There are also zero-coupon bonds where no interest coupons are paid, however, the bonds are issued at a discount on their face value and redeemed at face value. 

For example, if a bond has a face value of ₹100. It is issued at a 20% discount, meaning ₹80 and on maturity is redeemed at face value, meaning ₹100. So, the investor ends up earning ₹20 when the bond is redeemed at maturity. 

Difference Between S.I.P.s and Bonds

In the context of S.I.P. being Mutual Funds, S.I.P.s, with the exception of a few with special objective ones, depend on the market performance of its portfolio for gains and have a varying degree of risk depending on the composition of its portfolio. Bonds, on the other hand, are fixed-income securities as discussed above. Once you put your money in bonds, you are bound to receive a fixed return on it that does not depend on whether the issuer of the bond makes profits or suffers losses on your money. As far as risk is concerned, it is virtually risk-free. We use the word “virtually” because there is still a chance that the issuer of the bond might face bankruptcy in which case you may still lose your money, but that is highly unlikely. 

There is also a difference in the pattern of returns as Mutual Fund S.I.P.s reap gains in the form of dividends and capital gains on investments while bonds bring in coupon payments or bring in earnings in the form of difference between the price at which it is issued and at which it is redeemed.

Here is a table to summarise the differences between S.I.P and Bonds:

Pros And Cons Of Investing In S.I.P.s and Bonds

Investing in S.I.P.s - Pros

1. Diversification: Mutual Funds have a huge fund corpus that they can use to invest in different types of securities. They can invest money in stocks that differ on multiple bases. For example, some money is invested in stocks of companies belonging to the cyclical industry and some belonging to the non-cyclical industry. Some money is invested in companies in the introduction phase, some in the growth phase and some in companies in their maturation stage. Some money is invested in stocks while some is invested in fixed-income securities.
   This diversification brings double benefits to the investors. It reduces the risk of losses to lower than what would have been had an investor individually invested in stocks since they would not have been able to diversify their investment to the level mutual fund managers can. Further, it still provides a much higher return than what fixed deposits offer.

2. Low Investment: Mutual funds allow investors to start investing from as low as ₹100. This makes it much more accessible since even a college student who has no income and receives pocket money can start investing and reap the benefits that come with starting early.

3. No Capital Market Research: Once the investor chooses the mutual fund ideal for them, they do not have to do any further research. Every further research - what stock to invest in, what stock to pull money from, whether to do passive investing or active investing etc is done by the mutual fund manager.

4. Professional Management: Mutual Funds are managed by managers who have years of experience in the capital market as well as managing funds. This reduces the risk of errors and usually ends up with the fund generating more gains than what an individual investor could generate.

5.  Liquidity: Mutual Fund Investments are highly liquid. Unlike fixed deposits, you can easily invest more money in the middle of your investment mandate by buying more units and can as easily sell those units to pull money out as and when required.

6. Tax Benefits: Investors investing in certain mutual fund investments such as E.L.S.S. can avail tax benefits under Section 80C of the Indian Income Tax Act. 

To know more on SIP based tax benefits, read the following article:

www.insurancedekho.com/investment/news/sip-tax-benefits-under-section-80c

Investing in S.I.P.s - Cons

1. No Control Over Investments: Since the individual investor is not in charge of the mutual fund, they can not choose what securities the fund will invest in. Surely, they can take the mutual fund’s objectives, risk profile and promised returns into consideration and match them to their needs. But, there is no control over the individual securities the fund invests in.

2. Risk: Since mutual funds invest in equities too, there is always a chance that the investment underperforms and the investor bears a loss.

3. Management Fees: Mutual Funds charge fees for managing your investments which can be avoided when investing individually.

Here is a table to summarise the points discussed above on S.I.P:

Investing in Bonds - Pros

1. Confirmed Income: Since bonds are fixed-income securities whose returns do not depend on the market performance of the underlying asset, they generate a fixed income in the form of interest and repayment of capital. Of course, the pattern of return varies depending on the type of bond.

2. Virtually risk-free: Both, the risk of the underperforming of the underlying asset and the risk of the issuer defaulting is very low, especially if the bond is issued by the government.

3. Tax Benefits: Investors investing their money in bonds can avail tax benefits under Section 80CCF of the Indian Income Tax Act.

4. Protection against inflation: Investing your money and earning a fixed return on it in the form of interest leads to you preserving the entire capital invested plus protection against depreciation in its value over time due to inflation. This protection, however, only works if the inflation rate does not rise faster than the interest rate.

Investing in Bonds - Cons

1. Default risk: Despite mentioning that investing in bonds is “virtually” risk-free, there is still a very small risk of the issuer going bankrupt which may end up in you losing your money.

2. Liquidity risk: Once the money is invested in bonds, the repayments only come as per the pre-determined pattern. However, unlike mutual funds, it is not possible to withdraw the invested money in whatever amount one wants as and when one wants.

3. Inflation Risk: If the inflation rate rises faster than the interest rates your money would still lose its value due to inflation. However, it would still be better than not investing as the fall in value due to inflation would be steeper in that case.

4. Bond Price Fluctuations: Bonds are tradeable in a secondary market. Since bond prices are inversely related to interest rates, if the interest rate in the market rises, it could end up with your bond losing its value proportionately. 

Here is a table to summarise the points discussed above on Bonds:

Starting Your Investment In S.I.P.s 

Step 1: Get Your Documents Ready

The first step is to understand all the documents you may require to start your S.I.P. in the mutual fund of your choosing. Usually, the documents required include an AADHAAR Card for ID proof along with proof of address like a driver’s licence or a passport. PAN card and bank account details also are required. That being stated, the website must continually be checked before investing to make sure no required documents are left out.

Step 2: Get Your KYC Done

KYC is done by the Government with the purpose of preventing unethical practices like financial fraud and money laundering. It is largely a background check and can be done both through online and offline processes. 

To get your KYC done offline, you can simply download the KYC Form from the websites of Fund Companies, AMFI or RTAs, fill it and finally, submit it at the Fund House’s Office or RTA. You can also get your KYC completed from the comfort of your house. Just fill out the KYC form which can be accessed at the Fund Company’s website, or AMFI’s or RTA’s website.

Step 3: Registration

The third step involves getting yourself registered with an Indian financial institution or a Mutual Fund broker.

Step four: Choose The Mutual Fund Investment Scheme

This is a personal choice. Different schemes are suited to different investors since their circumstances and goals are different. In order to know what factors should be kept in mind while deciding what scheme is the correct scheme for you, you can read the article ”How to start an S.I.P. in Mutual Funds”.

Step 5: Determine The Amount And Interval For The Systematic Investment Plan

Mutual Fund Investments are designed to make them accessible to all kinds of investors. In order to accomplish that, they allow various kinds of investors to make investments in amounts they would be comfortable with, without having a toll on their pocket at intervals they opt for. Hence, you need to set the amount you would like to invest and at what intervals. In most instances, considering you have already provided your bank account information, this pre-set amount is deducted from your bank account directly.

Step 6: Submit The Form

Upon completing all the previous steps, you just have to submit the form that is available on the website of your Mutual Fund company.

Starting Your Investment In Bonds

Step 1: Get Your Documents Ready

Just like investing in an S.I.P., investing in bonds also requires ID Proof and Address Proof such as an AADHAR Card, PAN Card or Passport, your bank details and some bonds may even require details about your income. 

Step 2: KYC

The process and significance of a KYC (Know Your Customer) is already discussed above.

Step 3: Buying The Bonds

Bonds can simply be bought just like equity securities. You may invest in bonds by buying them through an online broker, buying them directly from the Indian Government through the Reserve Bank of India's (RBI) Retail Direct Scheme or even combining the two types of investments and buying Exchange Traded Funds that invest in various kinds of bonds.

Frequently Asked Questions

1. Are debentures and bonds the same?
   While both bonds and debentures are fixed-income securities and may have similar terms, debenture is a term used to refer to bonds issued by corporations while bonds can be issued by governments, municipalities, and other entities. Further, bonds can be secured or unsecured while debentures are always unsecured.

2. Can bonds and S.I.P.s be combined?
   Yes, there are S.I.P.s called Exchange Traded Funds (E.T.F.s) that invest only in bonds of various kinds. A person investing in such E.T.F.s may reap the benefits of both S.I.P.s as well as bonds.
   
   

3. Are tax benefits earned on bond investments earned on the amount invested or on returns?
   Either of the two and only one at a time. What that means is if you are investing in a Tax-Free Bond, there is no tax to be paid on the interest earned on it however there are no tax benefits on the investments made in such bonds. If you invest in a Tax Saving Bond, on the other hand, the interest earned is taxable but tax benefits can be availed on the amount invested in these bonds under Article 80CCF of the Indian Income Tax Act.