Earning from cumulative payout of bonds is higher than from regular payout
If you don’t need monthly income or annual payouts, it’s best to opt for a cumulative payout if that option is available
With a spate of public issues for non-convertible debentures (NCDs) in the market for retail investors and more to come, you will find yourself spoilt for choice picking a bond to invest in.
Each issuer also has more than one option for you to choose from. One of these choices is picking a bond which gives you regular interest payout versus one which gives you a cumulative payout. Here is how you can decide which one will work for you.
In this option, the bond will pay a defined interest called coupon which tells you the annual earning you can get from that bond. For example, a coupon of 9% means for every bond with a face value of Rs1,000 you will earn Rs90 in one year. In other words, on a Rs1 lakh investment, you will make Rs9,000.
You need to check whether the coupon is payable annually, semi-annually, quarterly or monthly.
Your choice of annual versus monthly or any other frequency of payout will depend on your requirement for regular income. So if you need monthly income, opt for monthly payout.
Keep in mind though that the coupon is always shown as an annual interest number, but if your payout option is say semi-annual, you will get half of the amount every six months. Similarly, if your payout option is monthly, you will get one-12th of the amount or Rs750 every month, for an investment of Rs1 lakh with a 9% annual coupon.
The cumulative option adds annual interest amounts for each year of the bond’s tenure and pays the full amount at the end.
Usually, the cumulative option return is not shown as a coupon or interest rate, but is an absolute number. For example, for a bond of face value Rs1,000, the cumulative option may offer a payback of Rs1,350 at the end of three years.
To understand how much return you are making in the cumulative option, say, against an annual payout option, you can add up your annual interest payouts for three years along with the principal amount invested and compare it with your cumulative amount.
Usually, the cumulative payout for the same interest rate works out to be higher as the annual interest is added to the initial principal amount for calculating the interest in the next year.
This is called compounding and it enhances the return you make. This is unlike the simple payout option which calculates interest paid out each year only on the original amount invested.
If you don’t need monthly income or annual payouts, it’s best to opt for a cumulative payout if that option is available.
To read more about the options currently available in the market—NCDs of Dewan Housing Finance Corp. Ltd (DHFL) which is open to the public and JM Financial Credit Solutions Ltd which opens on 28 May—go to bit.ly/2IFg09X