Monthly Interest Payout Option May Not Always Be The Best Option

Date : 08/08/2023
Read: 3 mins

Monthly interests on non-convertible debentures, and the payout option of bonds, have several drawbacks. Read on to know more.

Companies issue non-convertible debentures to raise funds for a set period. They work like fixed deposits and can be traded on stock exchanges. Investors receive regular interest and get their principal back when the debenture matures. And lately, some public issuances of non-convertible debentures (NCDs) provide monthly interest payouts.

In this article, we’ll look at why that’s not the best option.

Highlights:

Understanding bonds as a viable method for investment.
Analysing drawbacks of monthly interest payout options for investment in bonds.
The need to make the right choices when investing in mutual funds or bonds.\

Why are Bonds Considered for Investment?

Beyond their potential for capital preservation and regular income, bonds provide investors with various benefits. The capacity to generate steady and dependable cash flows is one notable advantage. By comprehending their workings, individuals can use bond investments and interest payouts to establish a reliable cash flow source.

Why not use the Monthly Interest Payout Option on Bonds?

When investors regularly receive money, they might be tempted to spend it on unnecessary or impulsive purchases. This can hurt their investment returns and reduce the overall value of their portfolio.
If they keep the received funds in a regular savings account, they usually earn a low-interest rate, around 3%. This means they could miss out on better investment options with higher returns, like corporate fixed deposits offering 6.5 to 7% for one year.
When they receive interest payout options, the prevailing interest rates might be lower than the original rate, impacting future returns. Changing interest rates can limit their reinvestment options.
Interest payouts from bonds are taxed at the investor's income tax rate. Choosing yearly payouts can delay tax liability. However, investing in debt mutual funds (MFs) can offer tax advantages as they reinvest coupon payments, deferring taxes until the units are sold, potentially benefiting from lower tax rates during retirement.

Also Read: 8 Key Differences Between Bonds & Debentures

How to Make Sound Decisions?

Interest rates and bond prices have an opposite relationship. When rates rise, bond prices go down, and vice versa. This affects a bond's value before its maturity as rates change. But many investors need to realise this.

Owning a bond or having a highly regarded one doesn't guarantee dividends or redemption. The bond's performance depends on various factors.

Market perception of the bond and issuer creates volatility. If others doubt the issuer's ability to meet obligations or its reputation suffers, the bond's price drops.

A useful tip for bond investors is to check the issuer's common stock. It provides insight into the issuer's financial health and market perception, which affects bond performance.

Understanding the bond market involves considering interest rate fluctuations, market perception, and issuer reputation. It is also important to focus on systematic withdrawal plans, and bond investors should analyse these factors to make informed decisions.

Also Read: Importance Of Bonds In Your Portfolio

The requirement for standard liquidity and the apprehension about loss in case of default are among the reasons that urge investors to look for interest payouts in monthly intervals. Such a payout option should be avoided even if it means regular income on bonds.