What do I need to buy tax free bonds?

by Manshu on November 21, 2012

in Fixed Deposits

A friend recently emailed asking for suggestions on investments for her baby girl, and I suggested that tax free bonds are going to be issued later this year, and that’s a good option for you.

She asked what she needed to invest in them, if she needed a Demat account, and I thought it would be a good idea to write about three things that I think everyone should consider (not necessarily need) if they want to invest in tax free bonds.

You need a Demat account to buy tax free bonds

As far as I can remember all tax free bonds needed Demat accounts last year, and although I haven’t checked all older posts, the ones I saw mention that a Demat account is needed.

Now, as far as who you should open that with – I think there is very little difference apart from cost and even with cost it doesn’t vary a lot.

Tax free bonds already listed in the market

The next thing to consider is that you can buy tax free bonds already listed in the market so the new bonds should be compared with what’s on offer already. The tax free bonds that are issued this year will very likely have a lower interest rate than the ones issued last year but because the price of the existing bonds has risen up in the past few days it may still be just better to buy the new bonds.

We have to wait and watch what happens but that’s one comparison that is useful, and when the terms of the bonds are out, I will have that on here.

Tax free bonds don’t reinvest your interest

There was a very lively debate last year among readers on the returns calculation from a SBI fixed deposit that compounds your interest 4 times a year, and then you can reinvest this money for a longer term, something you can’t do with a tax free bond as it pays you the interest every year without the reinvestment option.

I did a very detailed post with calculations that showed comparisons between the two, but I think Hemant did a much better job explaining how this affects returns and you should read point 2 from the post before investing in these bonds.

The takeaway is that if you don’t reinvest the interest from the bonds, and just spend it away then you aren’t going to make too much.

Conclusion

Finally, though not really the topic of this post, if you’re planning investments for your baby or retirement or buying a car or just about anything, just one product will not give you the best results. You have to mix and match and buy a few things to get the most out of your money.

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