Many Indian investors look at bonds as the calm side of their portfolio. They are usually safer than shares but they are not risk free. Before you invest in bonds it helps to understand the main types of bond risks so you know what you are being paid for and how to protect yourself.
1. Credit risk
Credit risk is the chance that the issuer fails to pay interest or principal on time.
A Government of India security has very low credit risk in rupees. A small unrated company carries much higher risk even if the coupon looks attractive.
Rating agencies study the balance sheet cash flows management quality and business stability then assign a rating. Higher rated bonds normally offer lower returns because the chance of loss is smaller. Lower rated bonds have to offer higher yields to tempt investors.
How to manage it
- Prefer sovereign and top public sector issuers for the core of your debt allocation
- Add only selected strong private issuers after checking rating and basic financials
- Avoid chasing extreme yields from names you do not understand
2. Interest rate risk
Bond prices move in the opposite direction to interest rates. When market rates rise prices of existing fixed coupon bonds fall. When rates drop existing bonds with higher coupons become more valuable so prices rise.
Longer maturity bonds are more sensitive to these moves than short maturity ones. This is a major part of the day to day noise you see in the bond market.
How to manage it
- If your goal is near term prefer short maturity bonds or short duration debt funds
- For longer goals build a ladder with different maturity years so you are not locked into one rate forever
- Remember that if you hold a good quality bond till maturity price changes in between are mostly on paper
3. Reinvestment risk
Many bonds pay interest every six months or every year. Reinvestment risk is the possibility that when you receive this interest rates in the market have fallen so you have to reinvest at a lower rate.
This matters most in falling rate cycles. Your original yield to maturity assumes you can reinvest coupons at similar rates which may not actually happen.
How to manage it
- For goals with a clear date use products that line up maturity with that date so reinvestment needs are lower
- Consider some deep discount or target maturity structures where more of the return comes at the end instead of through frequent coupons
4. Liquidity risk
Liquidity risk is the chance that you cannot sell a bond easily when you need money. Some large government and public sector bonds trade actively. Many smaller issues hardly trade at all.
If you own an illiquid bond you might have to accept a lower price to exit quickly or wait longer than you planned.
How to manage it
- Check whether the bond trades regularly and in what size
- Keep the bulk of your money in more liquid issues or in debt funds that handle trading for you
- Use illiquid bonds only for amounts you are genuinely willing to hold till maturity
5. Inflation and purchasing power risk
If inflation stays high the real value of your interest income drops. A bond that pays seven percent looks fine until you see that your cost of living is rising at six percent. After tax the real gain may be very small.
How to manage it
- Look at post tax returns and compare with expected inflation not only with bank deposit rates
- Do not put all your wealth into fixed income. Combine bonds with equity and some gold so the overall portfolio can keep up with rising prices over time
6. Behaviour and concentration risk
There is also a human side to risk. Many people panic when prices fall and sell at the worst moment or get greedy when they see double digit coupons from weak issuers. Others put too much money into one company or one sector.
How to manage it
- Spread your bond exposure across issuers sectors and maturities
- Fix simple limits for yourself such as not putting more than a small part of your fixed income money into a single issuer
- Decide in advance whether you plan to trade actively or hold quietly till maturity
When you see all these types of bond risks clearly bonds stop looking scary and start looking like tools. Use safe sovereign and strong public sector names as your base then add carefully chosen corporate bonds for extra yield. Match maturities to your goals stay diversified and keep emotions in check. That is how the bond market can give you steady support while the rest of your portfolio works harder for growth.
