There are different ways on how the government and corporate raise funds to run their business. Out of the all, bonds and debentures are a popular means for raising funds.
What are bonds
A bond is a contract between the investor and the corporate entity, which states that the investor will provide the funds to the company in exchange for a defined interest on the investment made. They are usually backed by the assets of the company.
Bonds are typically regarded as a pretty secure investment. Thus, corporate or government bonds with high ratings have a low chance of being default.
What are debentures
Debentures are a type of bonds, but the only difference being that they are not backed by assets. Debentures are issued to the investors only on the basis of the trust and creditworthy of the company.
A trust indenture must be signed before a debenture may be issued. The first trust is a contract between the issuing company and the trustee who manages the investors’ interests.
Here are 5 reasons why bonds are better than debentures
- The investment in bonds are backed by assets
- Bonds provide security on the investment
- The bonds provide a decent rate of return
- Bonds are less risky compared to debentures
- Bonds are free from interest rate risk
Let us understand these points in detail.
The investment in bonds are backed by assets
The main reason why bonds are a better investment than debentures is that they are backed by assets. For example when the government issues Sovereign Gold Bond, they are backed by the Gold as an asset as an underlying for the bond.
On the other hand, when the debentures are issued, they do not have any backing of assets to hold any intrinsic value for their investment. If the company goes bust, the debentures cannot be converted into the equity of the company. Thus, investors need to have a high trust authority with the company for them to invest in their debentures.
Bonds provide security on the investment
Since the bonds are backed by assets they are much more secure than debentures. as an investor, one needs to consider the direct effects of high risk investment tools.
Investing in a low risk asset is way better than a high risk with extreme volatile returns and risk of losing capital.
When the company is unable to pay the returns to its investors, it is left with no option but to sell its assets and re-pay the bond investors with their principal amount. Thus, by investing in a bond one can assure that the principle amount is secured.
A lower risk on the investment also allows the investor to stay invested for a longer duration of time and take advantages of the effect of compounding.
The bonds provide a decent rate of return for long term investors
The rate of returns provided by bonds are usually in the range of 6-12 % per annum. As per a defensive investor, these returns are decently attractive compared to the returns provided by the other fixed instruments like the fixed deposits.
Bonds are less risky compared to debentures
Bonds have an intrinsic value. They are not just based on the trust factor, but are backed by assets that define the investment.
Bonds are free of interest rate risk
The rate of return provided by the debentures are not fixed. They tend to be dependent on the fluctuations based on the interest rate.
If the interest rates are lucrative the returns provided by the debentures will be good. While, the rate of return yielding from bonds is fixed.
This rate will not change depending in the external and internal factors. Due to this reason, the rate of return provided by the bonds is usually on the lower side.
Personally, I invest 50% of my capital in bonds. In order to reduce the risk on my investment, I select debt mutual funds. The role of these mutual funds is to diversify your money in bonds of different companies.
The major advantage of my money investing in debt mutual funds is that they are not heavily impacted by the stock market movements.