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Where do tax-free bonds score?

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TAX-FREE bonds have once again made an appearance on the investment horizon and this presents an opportunity for the investor to make the most of the choices available to them. The manner in which various factors have to be considered for decision making and the benefits that they offer are important for the investor. Here is a look at some of the features of tax-free bonds: Nature of bonds: The important point about taxfree bonds is that the interest earned here is not liable for taxation. This makes them different from other bonds wherein the interest is taxable.


Since the interest earned here is tax-free, it has to be excluded for the purpose of calculating the taxable income. Due to this reason, the distinction between the pre-tax and post-tax income becomes an important factor. The interest on these bonds is post-tax, so for a person to understand and make a comparison with the other instruments in the market, they would have to raise this to the pre-tax levels, which would again depend on the tax slab that they actually fall under. The comparisons for the investor thus need to be made very carefully so that the right rate of return is compared.


Long time period: These tax-free bonds are longterm investment instruments. Earlier they were available for the duration of 10 and 15 years only, but from this year, there has been an addition of another choice in the form of a 20-year bond. So, these bonds are meant only for those investors who want to put their money away for a long duration and would not require the funds in the interim period. This is crucial because short-term investors using this opportunity could find that they are in trouble on the liquidity front and hence, it might not match their specific requirements.


Higher interest rates: The interest rates on the bonds are dependent on the time period when they are issued. So for example, in the last financial year, the rates on these bonds were quite low. This year, however, there has been a change in the debt market conditions over the last few months and rates have risen in the open market. This has led to the interest rates also rising on these bond offerings.


There is a good chance for the investors to lock themselves into a higher rate for a longer time period.


The rate would change from issue to issue and also for the different time period options depending on when an institution requires fund, but a choice that matches the investor requirements can be made.


Interest choice: The investor would have the choice about taking an interest payout or accumulating this till the time of maturity. Those looking for a regular cash flow would do well to choose the option that pays out the amount because this will ensure that there is some cash flow that they are able to generate which matches with their needs.


Those not needing funds can easily go in for the cumulative option. The overall decision about the time of the investment and the choice of the payout would be significant as this is a long-term decision and hence, the consequences over the entire life would need to be considered for this purpose.

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