Is Investing in Sep-Oct 2015 Tax-Free Bonds of PFC a Good Idea?
Take this, take that! No, no, that one has a bad record. Holy crap, that’s gonna crash! You better invest in this bond. No, no, you are better off with gold bullion. Why not plunge in petro-dollar?
Whoa…whoa… that’s worse that the constant buzz of the busiest fish market you can ever be at! And yes…we are talking about the stock markets where you take risk and expect returns. And why not? Play well and you get a ticket to the shortcut of being rich! Sadly, the grass on the other side of the fence isn’t all green. Play bad and you are ruined.
Now that we have your attention and you are still hell-bent on investing, here is the sexy diva you need to look at – the Tax-Free bonds of Power Finance Corporation offering interest earnings of 7.6%. Subscriptions for this bond will open on October 5, 2015 and as we said, they are tax-free. So you get to keep all that you earn and not pay a single dime to the government!
Okay, the last part is just good enough to make you and me and everyone else drool.
Don’t run for it yet. There is time! So, sit and relax, eat some pizza with pepperoni topping and read on…
Allow us to walk you through the whole thing starting with PFC.
What is PFC?
Smart you! It is Power Finance Corporation. You nailed it. But the question is, “Why on earth are the words ‘Power’ and ‘Finance’ placed together?” Okay, it is a finance company but primarily focuses on India’s power sector. It works in unison with Government of India, State Governments, Union Territory Governments, other companies in power sector and large consumers of power in India’s business world. So, essentially, PFC is quite a heavy weight organization we are look at. It is a name that can be trusted.
So, why is PFC issuing bonds?
We love you because you ask smart questions! Here is your answer:
Any big company in need of liquidity will issue bonds or shares and promise high returns or guaranteed returns or whatever they want to offer. People buy those bonds or shares, companies take the money, invest that money and make profits and then return the money to the shareholders or bond holders along with the promised extra goodies. PFC is no different! So, you get it right? The extra goodie here is the 7.6% interest that is absolutely tax-free!
A slightly deeper look into PFC’s offerings
Let us take a look at what PFC has to offer. We will use a table if you don’t mind. Of course you don’t!
|Issue starts on||October 5, 2015|
|Issue ends on||October 9, 2015|
|Face value per bond||INR 1,000|
|Minimum required investment||5 bonds (total investment of INR 5,000)|
|Investment increment||Only one bond at a time after minimum investment|
|Interest rate for tenure of||10 years||7.36%|
|NRI investment type||Both repatriation and non-repatriation types|
|Lower interest rates applicable for||Qualified Institutional Buyers (get 0.25% less than quoted rates).|
|NRI investors (also get 0.25% less than quoted rates).|
|High Networth Individuals (also get 0.25% less that quoted rates).|
|Retail investors with INR 10 Lakh+ of investment. Please note that NRIs and High Networth Individuals (HNIs) are often considered as retail investors.|
|Interest payment frequency||Annually|
|Tax deductions||No tax deductions|
|Listing on||BSE only. Please note that if the investment earnings are channeled to a secondary market, capital gains taxes will be implemented.|
|Investment format||Physical bond holding or demat holding.|
It is important to note that the above quoted interest rates apply only and only to retail investors who invest anything below INR Lakh.
The Goods and the Bads
So, now that we know the features and a little bit about the company, here is a take on Goods and Bads of investing in PFC’s tax-free bonds:
A quick look at interest earnings:
These PFC bonds work differently for different tax brackets. We mean that they offer different overall earnings depending on the tax bracket you fall in. Here is how it works:
|Tenure of holding||Interest rate offered by PFC bonds||Pre-tax interest earning or effective yield for different tax brackets|
|30% tax||20% tax||10% tax|
If you opt to invest in a fixed deposit instead of PFC bonds, the maximum interest you can get is 9% or less than 9% (usually between 8 and 8.25%) and on top of that, the interest earning will be taxed.
So if you are in the highest or the second highest tax bracket, you actually benefit by investing in PFC. In case you are in the lowest tax bracket, you will be better off by investing in fixed deposits or in case of PFC, investment should be for at least 15 years. So, PFC is not really a good option for people falling in 10% tax bracket.
To sum up:
- Good if you are in higher tax bracket.
- Bad if you are in lower tax bracket.
A quick look at one-year history:
You know what, market interest rates fluctuate pretty frequently. Interest rate offered by PFC is 7.60% highest for maximum tenure. This interest will stay fixed for the whole tenure. What if the interest rate increases next year? You are stuck with a lower rate of interest. Let us take the example of last year. Tax-free debt instruments like this actually offered 8% interest without any tax deductions. This year it is low.
So, investing in PFC now can mean losses in the future. This is really bad unless of course you decide to prematurely sale these bonds. This is discussed in next point.
Price appreciation may happen which is good:
Bond prices and interest rates are inversely related. If one goes down, the other will go up. So, if interest falls further, the prices of PFC bonds will go up further. So, if you purchase the PFC bonds and then the prices go up you can sell these bonds prematurely (there are provisions for doing so) and earn some extra cash. This is good.
There will be risk of low liquidity:
PFC is a government bond which is known for its stability and low-risk. However, the major problem here is that these types of bonds are not traded on a frequent basis. So, selling them will be one hell of a difficult task, especially when you are looking for quick earnings from interest fluctuation in other markets, you may want some liquid cash to be available in hand. Investing in the PFC bonds will prevent you from selling them off easily to get liquid cash. This is bad, really bad, especially if you have high risk appetite and prefer to play with short term gains.
Major economic collapse:
Like it or not, US economy is on the verge of major economic collapse very soon. When US collapses, the world economic will take a big blow in form of recession. India is today world’s 3rdlargest coal importer and this coals is mainly used in power industry. As world economy tumbles down, India’s indigenous power sector companies will take a massive hit. Losses taken by these companies will eventually reflect in PFC’s balance sheet. What happens then? You get it right?
In case you are not aware of how and why US economy will collapse, just Google it and you see experts talk about the imminent threat. Just a heads up about your research, US nation debt is now at 18.4 trillion USD. USA is completely bankrupt and Obama administration is gradually making it worse by every minute.
What do we suggest in this scenario? Maintain liquidity, play in short term investments and hold as much gold as possible because we will soon move into gold as world reserve currency.
There are alternative investment options like Mutual Funds that have way higher returns. In fact, there are some that have double interest rate as offered by PFC bonds and they are known for their safety. Even if you end up paying tax on your interest earnings from those bonds, you can still earn more.
Essentially, the advantages and disadvantages of PFC’s tax-free bond offerings are more or less balanced. However, your risk appetite and your understanding of how the whole world economy is integrated will determine whether you want to invest in PFC or not.
If you are asking for our opinion then we will say, avoid it because we prefer high risk markets and quick investments and we are also wary about the economic imbalance that is building up in US economy and European frontier. In such situations, we will always and always try to avoid anything that calls for long term investments. Now it is your decision.