Thursday, December 1, 2011

Want to invest in infrastructure bonds? Do it now, don't wait for better yields

It is almost that time of the year again when you need to submit proofs of investments made by you to make sure the tax deducted from your salary takes into account such investments. Infrastructure bonds are one of the investment options to save tax. Investments of up to Rs 20,000 in such bonds qualify for tax exclusion.

Currently two companies are offering such bonds - IDFC and L&T Infrastructure Finance, both offering an interest rate of 9% per annum. The terms of the two issues are very similar except that IDFC bonds enjoy AAA rating whereas L&T Infrastructure Finance's bonds are rated AA+.

The post-tax returns in both cases work out to 10.85% (for those in the 10.30% tax bracket), 13% (20.60% tax bracket), and 15.56% (tax rate 30.90%). The returns are definitely good. This, of course, assumes that you will use the buyback facility provided by the company at the end of five years and that the tax rate will remain constant throughout the five-year period.

Investment in infrastructure bonds makes sense for all tax payers given the good posttax returns. But investments of up to Rs 20,000 per tax payer qualify for deductions. Beyond that, there are several other debt options that provide better returns. The only decision, therefore, that remains for the tax payer to take is: Should you invest now or wait for better yielding infrastructure bonds in the next quarter?

This question is natural given last year's experience where those who waited till the last minute got better interest rates. Companies offer interest rates on the bonds based on the returns on comparable government securities for the prescribed period before the issue of the bonds.

The government securities market is very volatile and is expected to remain so. Hence, it is difficult to predict whether future issues of such bonds are likely to carry the same or higher (or even lower) interest rates. Given the fact that this investment should be limited to Rs 20,000, it is unlikely to make a major difference (either way) to an investor and, hence, it is always better to get a highly-rated bond when available.

Should you opt for the buyback option after five years or wait till the five-year lock-in period is over and then decide whether to continue with the bond for a further period or opt for the buyback option? Your bonds will be priced at a premium if you continue with the bond and if the interest rates for a five-year bond are ruling lower than 9% at the end of five years.

You can, however, suffer a capital loss if you continue with the bonds at the end of five years and if the interest rates for such bonds is higher than 9% at that time. Given the low value of the investment vis-a-vis a high taxpayers overall investment portfolio, it is most unlikely that you will do a proper review before taking this decision. Hence, make inertia work for you.

Choose the buyback option while applying for the bond so that your returns are locked in. If you are able to take a proper review at the end of five years, you are allowed to change your mind but at least your inertia in taking a decision will not cost you adversely. 

If you have decided to invest now, should you invest in IDFC or L&T Infra? Well, both are very similar, but IDFC clearly has an edge because it is rated a notch higher at AAA as against AA+ for L&T Infra's issue. Taxpayers might as well investRs 20,000 now in infrastructure bonds rather than waiting, and they can choose the buyback option while applying for the bonds. IDFC has an edge over L&T Infrastructure due to its rating. 
Source : ET

No comments:

Popular Posts