Bonds vs Debt Mutual Funds - Which is Better for NRIs

A question we hear often in our community: "Should I buy bonds directly or invest through debt mutual funds?"

Both are fixed-income instruments. Both promise stable returns. But they work very differently, especially when it comes to taxation, liquidity, and how NRIs can access them.

At Belong, we've helped many NRIs navigate this decision. The right choice depends on your investment horizon, tax bracket, and how hands-on you want to be with your portfolio. This guide breaks down everything you need to make that call.

The Tax Reality Has Changed Everything

Before we compare features, you need to understand the 2023-2024 tax changes. They've fundamentally altered the debt fund landscape.

For debt mutual funds purchased after April 1, 2023: All gains are taxed at your income slab rate. Doesn't matter if you hold for 3 months or 3 years. No long-term capital gains benefit. No indexation.

For debt funds purchased before April 1, 2023 and sold after July 23, 2024: Gains are taxed at 12.5% if held over 24 months. No indexation benefit here either.

For bonds: Interest income is taxed at your slab rate. Capital gains (if you sell before maturity) follow the 24-month rule, with 12.5% LTCG for longer holdings.

This means debt mutual funds have lost their tax advantage over fixed deposits. The playing field is now level, and your decision should be based on other factors.

👉 Tip: If you're in the 30% tax bracket, both bonds and debt funds will be taxed heavily. Consider GIFT City alternatives for tax-free fixed income.

What Exactly Are Bonds?

Bonds are loans you give to governments or corporations. They promise to pay you fixed interest (called coupon) at regular intervals and return your principal at maturity.

When you buy a bond, you know exactly what you'll earn. A 7.5% government bond paying semi-annually will give you ₹3,750 twice a year on a ₹1 lakh investment. At maturity, you get your ₹1 lakh back.

Types of bonds NRIs can invest in:

NRIs can invest in bonds through designated banks or brokers using NRE/NRO accounts. You'll need a demat account and must comply with FEMA guidelines.

What Are Debt Mutual Funds?

Debt mutual funds pool money from multiple investors to buy a diversified portfolio of fixed-income securities. A professional fund manager decides which bonds, treasury bills, commercial papers, and money market instruments to include.

Instead of picking individual bonds yourself, you're essentially hiring an expert to do it for you. The fund's NAV (Net Asset Value) moves based on the underlying portfolio's performance.

Common types of debt funds:

For a deeper dive, see our guide on corporate bond funds for NRIs.

Head-to-Head Comparison

When Bonds Make More Sense

You want predictable cash flow. Bonds pay fixed interest at regular intervals. If you need ₹50,000 every six months for your parents' expenses in India, bonds let you plan precisely.

You prefer picking your own investments. You've researched NHAI or REC bonds and believe in their creditworthiness. You want control over exactly what you own.

You're holding until maturity. Interest rate fluctuations won't affect you if you're not selling before maturity. You'll get your promised coupon regardless of market conditions.

You want tax-free bonds. Certain bonds issued by government entities offer completely tax-free interest. These are rare now but can be bought in the secondary market.

👉 Tip: Tax-free bonds trade at a premium in the secondary market. Calculate your effective yield after paying the premium, not just the stated coupon rate.

When Debt Funds Work Better

You want professional management. Fund managers track interest rates, credit quality, and duration actively. They can adjust the portfolio when market conditions change.

You need flexibility to exit. Open-ended debt funds let you redeem anytime (subject to exit load). Bonds lock you in until maturity unless you sell on exchanges, often at a discount.

You're starting small. With SIPs starting at ₹500, debt funds are more accessible than bonds which often require ₹10,000-1 lakh minimum.

You want diversification without effort. One debt fund might hold 50+ securities across issuers. Achieving similar diversification with direct bonds would require significant capital and research.

You don't have a demat account. Debt mutual funds can be bought directly through AMCs or platforms without a demat account. Bonds require one.

For more on selecting the right fund, check our guide on how NRIs should select debt mutual funds.

Tax Treatment: The Complete Picture

This is where NRIs need to pay close attention. The rules differ based on what you invest in and when you bought it.

Debt Mutual Funds (Post-April 2023 purchases):

• All gains taxed at your income slab rate
• TDS: 30% on capital gains for NRIs (Source: ClearTax)
• No LTCG benefit regardless of holding period

Bonds:

• Interest income: Taxed at slab rate (TDS applicable)
• Capital gains: 12.5% if held over 24 months, slab rate otherwise
• Tax-free bonds: Interest completely exempt

For NRIs specifically: TDS is deducted at source. For debt fund redemptions, expect 30% TDS on gains. For bond interest, TDS varies by bond type. You can claim DTAA benefits to avoid double taxation.

Since both are now taxed at slab rates, the tax advantage debt funds once had over bonds has disappeared. Your decision should focus on liquidity, management preference, and investment size.

Understanding the Risks

Neither bonds nor debt funds are "risk-free." Here's what can go wrong:

Credit Risk The issuer might default. Corporate bonds carry higher credit risk than government securities. Debt funds spread this risk across multiple issuers, but a single default can still hurt NAV.

In 2019, several debt funds took significant hits when IL\&FS and DHFL defaulted. The lesson: check credit ratings carefully. Stick to AAA or AA+ rated instruments.

Interest Rate Risk When interest rates rise, bond prices fall (and vice versa). This affects both direct bonds and debt fund NAVs.

If you hold a bond to maturity, rate changes don't affect your returns. But if you're in a debt fund or need to sell bonds before maturity, interest rate movements matter.

Liquidity Risk The Indian corporate bond market isn't as liquid as equity markets. Selling bonds before maturity might mean accepting a discount. Debt funds face similar issues during market stress when redemptions spike.

👉 Tip: For short-term parking of funds (under 1 year), liquid funds are safer than longer-duration debt funds or bonds.

How NRIs Can Invest

For Bonds:

1. Open an NRE/NRO account with a bank
2. Open a demat account with a broker
3. Complete KYC verification
4. Buy bonds through RBI Retail Direct (for G-Secs) or your broker
5. Ensure FEMA compliance for repatriation

For Debt Mutual Funds:

1. Have an NRE/NRO account ready
2. Complete mutual fund KYC (no demat needed)
3. Invest directly through AMC website or platforms
4. Redemption proceeds credit to your linked NRI account

The debt fund route is simpler. No demat, no broker involvement, easier KYC process. This is why most NRIs prefer debt funds over direct bond investing.

For step-by-step guidance, see our NRI mutual fund investment guide.

What About Regular Income Needs?

Many NRIs invest in fixed income to generate regular cash flow, often for parents in India or future retirement expenses.

Bonds: Pay coupon at fixed intervals (usually semi-annually). You know exactly how much you'll receive and when.

Debt Funds: The IDCW (Income Distribution cum Capital Withdrawal) option pays out periodically, but amounts aren't guaranteed. The Growth option compounds returns but provides no regular income.

If predictable cash flow matters, bonds have an edge. But consider the SWP (Systematic Withdrawal Plan) approach with debt funds, which lets you withdraw fixed amounts monthly while keeping the rest invested.

The GIFT City Alternative

Here's what most comparisons miss.

GIFT City fixed deposits and GIFT City funds offer NRIs something neither bonds nor regular debt funds can: zero capital gains tax.

These are USD-denominated instruments in India's International Financial Services Centre. Returns are competitive (5-6% on USD FDs), and you avoid the slab-rate taxation that now applies to both bonds and debt funds.

Through Belong, you can compare GIFT City FD rates and explore tax-free fixed income options. For NRIs in higher tax brackets, the tax savings alone can add 2-3% to your effective returns.

Our Recommendation

After working with hundreds of NRIs, here's our framework:

Choose bonds if:

• You want guaranteed, predictable income
• You're comfortable with research and self-management
• You're holding to maturity
• You can invest ₹5 lakh+ for meaningful diversification

Choose debt mutual funds if:

• You want professional management
• You need liquidity and flexibility
• You're investing smaller amounts
• You don't want to maintain a demat account

Consider GIFT City if:

• You're in the 20-30% tax bracket
• You want USD-denominated safety
• Tax efficiency is a priority
• You're planning for retirement or long-term goals

The tax changes of 2023-2024 have leveled the playing field between bonds and debt funds. Neither has a clear tax advantage anymore. Your choice should be based on convenience, control, and how much effort you want to put into managing your fixed-income portfolio.

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