# Comparing Tax Free Bonds and SBI Fixed Deposit Returns

There has been a lively debate about how to compare the yield between tax free bonds like NHAI and something like a ten year SBI fixed deposit in the comment section of the NHAI tax free bond. This debate was started by a calculation from Amlan Basak, and then others have weighed in on his calculations.

Savio had made a similar comment a few days ago, and basically what they are saying is that since bank fixed deposits are compounded 4 times a year, whereas the bond interest is compounded only once a year – the returns from a SBI bank fixed deposit is going to be higher than a PFC or NHAI bond issue in the long run.

Let me reproduce Amlan Basak’s comment here because he is the one that has done the calculation.

Currently SBI is giving 9.25% for 10 years FD.
letâ€™s assume you invest 1,00,000.
With quarterly compounding interest the maturity amount will be 2,49,544 (though it is surprising but it is the power of compounding).
Interest component = 1,49,544
Tax @30.9% = 46,209
So, effective maturity value = 1,00,000+1,49,544-46,209=2,03,335

for NHAI, simple interest of 8.2% will yield 82,000 in 10 years
So, final amount = 1,82,000
It is less by 21,335

Please let me know if I made any mistake in the calculation.

(Note: I am not considering how we are going to invest the 8200 per year that we will get as interest)

There are a few things that I want to highlight in this calculation.

First point and he has himself acknowledged that is the fact that he has not included the NHAI interest amount reinvestment in his calculation. So, on one hand you have the SBI money that is put to work by you at the high rate of interest but on the other hand you have the interest amount from NHAI or PFC that is not reinvested but is supposed to do nothing at all.

 Scenario NHAI SBI Fixed Deposit Money from NHAI is not reinvested & money from SBI is reinvested. Tax Rate is 30.9% Rs. 1,82,000 Rs. 203,335

If you hadÂ  assumed that the NHAI interest is also reinvested at the 8.2% that is the original bond’s coupon rate then you actually get Rs. 2,19,923 which is about Rs. 16,000 higher than the SBI fixed deposit amount. This is probably theoretically, a more correct way of comparing these two.

 Scenario NHAI SBI Fixed Deposit If NHAI interest is also reinvested along with SBI interest Rs. 2,19,923 Rs. 2,03,335 If money from NHAI is not reinvested & money from SBI is reinvested. Tax Rate is 30.9% Rs. 1,82,000 Rs. 203,335

Reinvestment makes a big difference and another way to highlight that is to look at what would happen if you reinvested NHAI interest but simply took the SBI FD interest home with you every year.

 Scenario NHAI SBI Fixed Deposit If NHAI interest is reinvested but SBI FD interest is not reinvested Rs. 2,19,923 Rs. 1,66,170 If money in either is reinvested (Tax at 30.9%) Rs, 2,19,923 Rs. 2,03,335 If money from NHAI is not reinvested & money from SBI is reinvested. Tax Rate is 30.9% Rs. 1,82,000 Rs. 2,03,335

But coming back to the original calculation I can understand why Amlan Basak didn’t consider investing the Rs. 8,200 back from the bonds, and this is what Kiran tweeted out to me some time ago as well – that for most people they will not reinvest the money and it will just lie in their bank accounts. Hence for majority of investors the cumulative option on bonds is better than the annual interest one.

The thing to consider in this is that you don’t see anything from your SBI investment for 10 long years, but you are getting Rs. 8,200 paid out to you from NHAI every year. With the high inflation that we have today – you just can’t compare the absolute sums from the two investments. Rs. 2,03,335 is worth a lot less in ten years than it is today. So, to really evaluate these two cash streams you should see the present value of these two cash flows. That means you see what the maturity amount ten years from now is worth in today’s rupees and then compare that with the cash flows on the bond. In this case, the present value of cash flow from bonds is higher than the present value of the fixed deposit. I have assumed inflation to be at 7%.

 Scenario NHAI SBI Fixed Deposit Present value of money if money from NHAI is not reinvested and money from SBI is reinvested. Inflation is assumed 7% throughout Rs. 1,19,924 Rs. 1,03,365 If NHAI interest is reinvested but SBI FD interest is not reinvested Rs. 2,19,923 Rs. 1,66,170 If money in either is reinvested (Tax at 30.9%) Rs, 2,19,923 Rs. 2,03,335 If money from PFC is not reinvested & money from SBI is reinvested. Tax Rate is 30.9% Rs. 1,82,000 Rs. 2,03,335

I have done all these calculations on a Google Spreadsheet that you can access here. It is read only so you can copy it to your own spreadsheet and make changes.

Another aspect of these numbers is that you are supposed to pay tax on the interest income every year so that will reduce what you get at the end of year. This has been pointed out by Vaibhav.

The take away for me has been that these bonds don’t offer as sweet a deal as I earlier thought them to offer and thanks to Amlan Basak and Savio for that. However, if I had an option I would definitely opt for the bonds instead of the SBI fixed deposit.

Since this has been a complicated exercise I won’t be surprised if I made mistakes, so I’d request you to review the numbers and point out if I made any errors. And like always, comments are welcome!

## 53 thoughts on “Comparing Tax Free Bonds and SBI Fixed Deposit Returns”

1. Alamelu,
Please recheck your calculation.Even if you reinvest the returns from Tax free bond in RD you wont get benefit for 20% and 10% tax bracket.My calculations provided above is verified to be correct.For 30% bracket there is a very slight benefit.Please see Hemant Beniwals post aswell.
Also you have mentioned RD wont attract TDS. Its only that bank is not deductingTDS.Legaly I believe,you are supposed to pay tax on the returns. So you cant compare returns from RD to be tax free.
Also we need to wait until March to know if there is a change in tax slab!If the last slab is increased,FD is gonna win this hands down….

2. alamelu says:

Slight mistake in the above – interest is paid annually for the taxfree bonds
and quarterly w/o discounting for Bank FD

hence the upfront investment (returned after one period) is
one year’s interest for Taxfree bonds and one quarter for FD

But the returns show that TFB outshines FD, even for 20% senior
so imagine 30% non-senior!

3. alamelu says:

Why even imagine that you wouldn’t reinvest the interest from either scheme?

For a small upfront investment of two months’ interest, you can set up a recurring deposit which fetches >9% interest and is not subject to TDS.

Inflation affects both schemes equally, so can be disregarded

Hence my calculation shows that a Cumulative deposit at 10.25%
(senior) at say IDBI, fetches only (after TDS at 20%):
after 10 years: 191684.17
after 15 years: 265386.84
IR 10.25
A Q1 Q2 Q3 Q4
1 100000 101640 103307 105001 106723
2 106723 108473 110252 112061 113898
3 113898 115766 117665 119595 121556
4 121556 123549 125576 127635 129728
5 129728 131856 134018 136216 138450
6 138450 140721 143028 145374 147758
7 147758 150181 152644 155148 157692
8 157692 160278 162907 165579 168294
9 168294 171054 173859 176711 179609
10 179609 182554 185548 188591 191684
11 191684 194828 198023 201271 204571
12 204571 207926 211336 214802 218325
13 218325 221906 225545 229244 233003
14 233003 236825 240709 244656 248668
15 248668 252747 256892 261105 265387

whereas taxfree bonds at 8.2 (better rates are available)
no TDS, and RD at same rate fetches:
after 10 years: 225175.09
after 15 years: 337894.04
IR 8.2
A Q1 Q2 Q3 Q4
1 100000 102050 104142 106277 108456
2 108456 110679 112948 115263 117626
3 117626 120038 122498 125010 127572
4 127572 130187 132856 135580 138359
5 138359 141196 144090 147044 150058
6 150058 153135 156274 159477 162747
7 162747 166083 169488 172962 176508
8 176508 180126 183819 187587 191433
9 191433 195357 199362 203449 207620
10 207620 211876 216219 220652 225175
11 225175 229791 234502 239309 244215
12 244215 249221 254330 259544 264865
13 264865 270295 275836 281490 287261
14 287261 293150 299159 305292 311551
15 311551 317937 324455 331106 337894

The latter investment is clearly better

4. Indubala says:

That was a very interesting discussion. Is it practical to evry year re invest your interest from bonds for the same rate? I disagree as many may forget the same also if interest proceeds are minimal you cant put reinvest easily. also bonds have a lock in period plus compound interest types that donot give the reinvsting option

5. Indubala says:

That was a very interestings discussion. Is it practical to evry year re invest your interest from bonds for the same rate? I disagree as many may forget the same also if interest proceeds are minimal you cant put reinvest easily. also bonds have a lock in period plus compound interest types that donot give the reinvsting option

6. One more point – A SBI FD is much more safer than Tax free bond.
Tax free status by government does not mean default risk free.Enterprises issuing tax free bonds do have government support but will have problems if losses go out of hand.
Layman like me always had misunderstanding of this government support!

7. Sorry! Slight correction in my previous post: wrongly entered the interest.It needs to be swapped for the lower tax bracket.
The tax free bonds have a very slight edge over SBI 10years FD for the 30% tax bracket ONLY.
For the less tax bracket SBI FD is BETTER than bonds.

AFTER TAX COMPNENT NET INTERESTS
30% bracket SBI = 7.35% Bonds = 7.61%
20% bracket SBI =8.14% Bonds = 7.81%
10% bracket SBI =8.88% Bonds = 8.01%

In my openion even for 30% bracket SBI FD is better for the following reasons.
1)You dont have a pain to reinvest the interst component
2)you dont know if u get a debt instrument that gives this kind of interest rates after a year
(you need to find for 10years for reinvesting the interest component of the bonds)

I am a layman in financial investments.However last 6 months I was doing agressive research to find out if my own financial plan is on track.My finding is :-
U need to research financial matters only if u r GREEDY !! If u r NOT GREEDY Stick to basics
options u have = equities,debt,gold,real estate.
for equities go for various Mutual funds based on ur risk and greed
debt = Highest rate FD,PF,PPF
Gold = Gold EFTs
Real estate = buy ur home + some land
Define ur goals and keep rebalancing ur investments.Dont research on products.There is going to be no better products if u look the long term horizon. Vines may appear in new bottles!!

8. The tax free bonds have a very slight edge over SBI 10years FD for the 30% tax bracket ONLY.
For the less tax bracket SBI FD is BETTER than bonds.

AFTER TAX COMPNENT NET INTERESTS
30% bracket SBI = 7.35% Bonds = 7.61%
20% bracket SBI = 7.81 Bonds = 8.14%
10% bracket SBI = 8.01 Bonds = 8.88%

In my openion even for 30% bracket SBI FD is better for the following reasons.
1)You dont have a pain to reinvest the interst component
2)you dont know if u get a debt instrument that gives this kind of interest rates after a year
(you need to find for 10years for reinvesting the interest component of the bonds)

I am a layman in financial investments.However last 6 months I was doing agressive research to find out if my own financial plan is on track.My finding is :-
U need to research financial matters only if u r GREEDY :-)!! If u r NOT GREEDY Stick to basics
options u have = equities,debt,gold,real estate.
for equities go for various Mutual funds based on ur risk and greed 🙂
debt = Highest rate FD,PF,PPF
Gold = Gold EFTs
Real estate = buy ur home + some land
Define ur goals and keep rebalancing ur investments.Dont research on products.There is going to be no better products if u look the long term horizon. Vines may appear in new bottles!!

1. Sticking to the basics will take you a long way and is much better than what most people are able to do who invest in hundreds of NFOs and insurance plans and just end up making agents richer.

That said, a couple of things I’ll add to what you said here is that if interest rates do go down a lot in the future then these bonds will rise in the market something which FDs don’t do.

Secondly, a rupee today is worth a lot more than the same rupee in ten years time. So, while you may get more in absolute terms in 10 years, it’s not quite correct to compare it with little amounts that you get over the years since inflation really does eat into the value of money.

1. Agree with you -Incase you are gonna trade,this can be useful.
Again agree with you – The little money u get in years may be not much affected by inflation.However this is more useful if u need this money for your monthly expenses.
Some one who is looking for a long term goal need to reinvest this not yet sure if this is very much beneficial.(As I said am not an expert :-))
It may give slight benefit for the higher tax bracket ones.

1. I think it will make a good article if you write a post about your journey, what you found in your research and how your thought process evolved….if you’re interested in writing such an article drop me a note through the Contact form.

9. harinee says:

WOnderful post again. I would have never known anything about these bonds if I wasnt following your blog.
One request I dont know if you have already done but would like a post on how the call/put options work, I can never seem to understand the how the bid pricing is set in Nifty options.

Thanks

1. Thanks Harinee.

I haven’t written much about Options or Futures but he pricing in general works on the market and people placing a bid and ask. There is an Black Scholes formula that’s widely used to refer to Options pricing but I’m not sure how many people really use it in real life.

10. Vivek says:

Excellent comparison and information shared.
My take on this is to invest your money in both FDs and bonds, neither of them is bad and it will maintain diversity in your profile. If you are inclined and favour one of the investments then keep the ratio higher in your favourite one. 60/40 or 70/30 depending on your likes but it is advisable to have a diverse portfolio.

1. I think that’s what most people will end up doing and it’s good also. Tax free bonds come up from time to time and it’s best to diversify and invest in a few of them to keep your risk spread out.

2. Diversification is basically for mitigating risks.Here though FD in a nationalised bank is safer than bonds, bonds too are not that unsafe. This too is a low risk instrument.
However I believe there is no point in preferring bonds over FDs.

Awaiting for final conclusions from Manshu,Hemant and the likes 🙂

11. Ramdas says:

Can we have a comparison between PPF and Tax free bonds .. as interest from both are tax free..

12. Hema says:

It is very confusing. The scenario should be same for NHAI and SBI and not like in NHAI reinvested and SBI not reinvested vice versa

1. The reason it got confusing is that if you consider one scenario then someone else will come up with something else and say that’s the better way to look at it and I wanted to preempt all of that, but I can appreciate why a lot of people are getting confused with this and will try something else the next time such a situation arises.

13. Manjunath says:

If money in either is reinvested (Tax at 30.9%) PFC Bond: Rs, 2,19,923 SBI FD: Rs. 2,03,335
The difference is Rs. 16,588. But is there a lock in period for the bond?
If the lock in period is five years.

Then my decision will need to be whether I would like to get additional Rs. 16,588 with having to lock in the money for 5 years? Is that right or am I missing anything else.

1. Yes, you’re right about the difference. There is no lock in period for the bonds.

14. Ajay says:

Manshu, you have highlighted what is known as reinvestment risk in Fixed Income. Your calculations assume a constant reinvestment rate for interest received through NHAI. I think the rate would actually vary depending upon the economy and what RBI thinks. Definitely a rate cycle cut is going to come up in the following months and interest rates would fall as a result. So NHAI bonds are more risk prone as we exactly do not know the rate at which we’d invest the interest. In this perspect, an SBI FD is more safer as we are locking the interest rate for the next 10 years.

1. Yes of course, but bond prices will also go up if interest rates go down and give you an option to earn capital gains.

Plus if you look at the present value of cash flows in the option where you don’t reinvest the bond interest – that’s a bit higher as well.

1. Ajay says:

Agreed that bond prices do go up. I’m not sure if capital gains on such a type of bond is taxed. If yes, then again it is an interesting scenario.

1. Yeah Ajay, they are going to get taxed the way other assets get taxed like a debt mutual fund for example.

15. Kazaak says:

I think there is a mistake in your calculation. You have calculated the total interest on the compounded maturity amount but the fact of the matter is you would be paying income tax each year based on accrual. Hence you would be compounding at much lower rate of interest or @ 6.39% (9.25 %*(1-0.309)) on a bank fixed deposit.

Also from a liquidity perspective, given the fact that we are in the beginning of a rate cut cycle, we would gain from capital appreciation in addition to the interest on the bond if we were sell it in the next 2-3 years cycle whereas on the fixed deposit, if we were to break the deposit for cash say after 2 years, we would earn a much lower interest(for 2 years the interest at that t ime is say 7%, then we get post-penalty 6% or 6.5% for the entire period of investment) and we would get into the hassle of claiming refund on the tax paid on a previous year (not sure we can even claim it).

1. Both of your criticisms are valid and I agree with them.

If you go to the spreadsheet you will see that I have given space for TDS deduction and you can alter that yourself and see eventually it doesn’t make a dramatic effect. I wanted to give SBI FD as much leeway as possible because the argument was that it’s better, so I chose the number that’s favorable to them.

16. its very discriptive calculation . SBI FD is liquid in case of emergency while there cauld be buyers for bonds but it depends .

1. Thanks Jasprit – just curious at to what happens when someone breaks a SBI FD – they get the rate equivalent to the time they had the FD but is there a penalty as well?

1. Manjunath says:

If money in either is reinvested (Tax at 30.9%) PFC Bond: Rs, 2,19,923 SBI FD: Rs. 2,03,335
The difference is Rs. 16,588. But is there a lock in period for the bond?
If the lock in period is five years.

Then my decision will need to be whether I would like to get additional Rs. 16,588 with having to lock in the money for 5 years? Is that right or am I missing anything else.

17. Similar calculations are done on the website jamapunji.blogspot.com
These seems to be the most realistic ones an it assumes no reinvestment of fixed deposit interest.
Also the tax related aspects are clarified for tax slabs including short term and long term capital gains tax.