Bonds Vs Debt Mutual Funds: Which One Is Better For NRIs?

NRIs who want to invest in debt instruments in India often face the dilemma of choosing between bonds or debt mutual funds. Both are fixed-income instruments that offer regular returns and capital preservation.

However, they also have some key differences that can affect their suitability for different investors.

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What are Bonds?

Bonds represent fixed-income securities issued by governments, corporations, or financial institutions to raise capital. These instruments promise to repay the principal amount along with periodic interest payments, known as coupon payments, to the bondholders.

At the end of the bond's tenure, you get back the principal amount. Bonds are generally considered safe investments as they have a predetermined cash flow and low default risk.

Like Indian residents, NRIs cannot invest in all the bonds available in the market. You can invest in

Public Sector Units and Capital Bonds
Non-Convertible Debentures (NCDs)
Government Tax-free Bonds
Treasury Bills
Infrastructure Bonds
Municipal and Zero Coupon Bonds

However, you can invest in zero coupon bonds from governments and PSUs but not from private sector companies.

Each type of bond carries different risk levels, returns, and tenures, catering to the diverse investment preferences of NRIs.

You can invest in these bonds directly through designated banks or brokers through your NRE/NRO accounts. However, you need a demat account to invest in Bonds.

Also, you must ensure that you comply with the Foreign Exchange Management Act (FEMA) rules and tax implications.

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What is a Debt Mutual Fund?

Debt mutual funds, on the other hand, pool investors' money to invest in a diversified portfolio of fixed-income securities such as bonds, money market instruments, commercial papers, certificates of deposit, etc.

A debt mutual fund is managed by a professional fund manager who decides the portfolio composition, duration, and credit quality of the fund. The fund managers aim to generate returns by investing in debt instruments with varying maturities and credit ratings.

A debt mutual fund aims to provide regular income and capital appreciation to its investors.

You can invest in a debt mutual fund in India without any restrictions. You can invest through your NRE or NRO accounts. Also, you can redeem the fund units at any time, subject to the exit load of the fund.

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Suggested Read - Debt Funds Mutual Funds for NRIs

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Key Differences Between Bonds and Debt Mutual Funds

The following table summarizes some of the key differences between bonds and debt mutual funds:

Debt Mutual Fund Information

Aspect	Bonds	Debt Mutual Funds
Investment Type	Individual fixed-income security	Basket of fixed-income instruments
Nature of Investment	Direct investment in fixed-income securities	Indirect investment through pooled funds
Risk	Risk varies, depending on the credit quality of the bonds. Government bonds carry the lowest risk.	Risk varies based on the underlying securities and fund portfolio
Return	Fixed returns based on coupon payments	Fixed but not guaranteed (depends on market conditions)
Liquidity	Lower liquidity, especially for long-term bonds	Higher liquidity, with the ability to redeem units at any time
Management	Self-managed (you choose the bond)	Professionally managed by a fund manager
Diversification	Limited (single bond issuer)	High (diversified across multiple instruments)

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What Should You Choose: Bonds or Debt Mutual Fund?

The choice between the two depends on your risk appetite, return expectations, and investment horizon. However, here are some general guidelines that can help you make an informed decision:

If you are looking for fixed returns and a concentrated investment portfolio, you can opt for bonds. However, you have to be careful about the credit quality, and liquidity of the bonds. You will have to identify the right bond for your investment goals and manage your investment portfolio (review and rebalance) all by yourself. And, also bear the interest rate risk of the bonds.
If you are looking for a diversified investment portfolio that is managed by professionals, you can opt for debt mutual funds. However, you have to be aware of the volatility and credit risk of the funds. You have to consider the exit load of the fund. Also, debt mutual funds are easily accessible to NRIs - you can invest online with just completing your KYC, you don’t need a demat account.

Balancing bonds and mutual funds in a portfolio is important, but be careful to avoid over-diversification mistakes. Find out more here.

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Scenarios Where Bonds Work Better

Bonds work better in the following scenarios:

You have a low-risk appetite and want to preserve your capital.
You have a specific financial goal and want to match your cash flow with your requirements.
You prefer to choose the specific bond issuer and lock in the interest rate.
You are looking to diversify and manage interest rate risk.
You are looking for an additional source of income → receive regular interest payouts.

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Scenarios Where Debt Mutual Funds Work Better

Debt mutual funds work better in the following scenarios:

You have a moderate to high-risk appetite and want to earn higher returns.
You have a flexible investment horizon and can take advantage of the market movements.
You want to diversify your portfolio and reduce your exposure to any single issuer.
You prefer a professional to handle your investment and navigate the complexities of the bond market.
Debt funds offer higher liquidity compared to fixed-maturity bonds, allowing you to redeem your investment partially or fully when needed (subject to exit loads).

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Conclusion

Bonds and debt mutual funds are both viable options for NRIs who want to invest in India. However, they have their own pros and cons that you have to weigh before making a choice.

While bonds offer stability and predictable returns, debt mutual funds provide diversification and professional management.

Ultimately, you should choose the option that best suits your risk profile, return expectation, and investment objective.

If you are confused about where to invest, it is wise to consult a financial advisor to pick the right investment for your goals. Happy Investing!

For those interested in comparing mutual funds with other managed investment services like PMS, read more here.

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Frequently Asked Questions (FAQs): Bonds Vs Debt Mutual Funds

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Is it better to invest in mutual funds or bonds?

Both debt funds and bonds are low risk investments compared to equity mutual funds. Debt mutual funds invest across different fixed income securities like bonds, government securities, money market instruments, etc. Thus, providing a diversified portfolio. And, mutual funds are managed by experienced fund managers who take care of shortlisting assets, investing and portfolio rebalancing. Investing in bonds requires you to hand pick a suitable bond that matches your investment horizon and risk appetite. And exposure to a single asset increases your investment risk.

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Can bond investments be made by mutual funds?

Yes, mutual funds can invest in bonds. However, you need to check the portfolio holding of a fund to understand the exposure to bonds.

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Can I sell bonds before maturity?

Yes, you can sell bonds on the secondary market before its maturity. The bond prices are determined by the prevailing interest rates.

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What happens if the issuer of a bond defaults?

In case of issuer default, you may not receive the promised return. You can pick bonds with high credit ratings to avoid any default issue. Usually the risk of default is lower for issuers with high credit ratings. Government bonds are considered to be the safest as they are unlikely to default.