Real Risks in Bonds: Why "Safe" Investments Lose Money.

Last Updated: December 25, 2025

There is a dangerous myth in India: "Stock markets are risky, but bonds and debt funds are 100% safe."

This myth shattered in 2020 when Franklin Templeton shut down 6 funds under Regulation 39(2) of SEBI Mutual Fund Regulations, citing severe illiquidity. More recently, in 2022, "safe" long-term gilt funds crashed by 10% as interest rates rose globally.

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1. Interest Rate Risk (The See-Saw)

This is the biggest killer of returns for long-term bond holders. Bond prices and Interest rates move in opposite directions—like a see-saw.

⚠️ The Logic: If you hold a bond paying 6%, and the RBI raises rates to 7%, nobody wants your 6% bond anymore. To sell it, you must lower the price until its yield matches the new 7% market rate.

This risk is formally defined in the RBI Master Direction on Investment Portfolio, which mandates that banks must maintain capital to cover this volatility (Market Risk).

2. Credit Risk (Default Risk)

This is the risk that the borrower stops paying interest or doesn't return the principal. A company might be rated "AA" today and downgrade to "D" (Default) in a month due to financial stress.

Safety Net: Government Bonds (G-Secs) carry a 'Sovereign Guarantee', meaning they have theoretically Zero Credit Risk. This is why G-Secs are termed "Risk-Free Assets" in RBI terminology.

3. Liquidity Risk (The "Hotel California" Effect)

In the stock market, you can sell blue-chip shares in seconds. In the bond market, many corporate bonds simply do not trade for days.

To address this, SEBI issued a circular on Prudential Norms for Liquidity Risk Management (June 2021), mandating that debt mutual funds must hold at least 10% of their assets in liquid instruments like Cash and G-Secs to meet sudden redemption pressures.

4. Reinvestment Risk

This is the risk that when your bond matures, you won't be able to find a new bond paying the same high interest rate.

📉 Example: You bought a 5-year FD at 8%. You were happy. Five years later, it matures. But now, market rates have fallen to 5%. Your income suddenly drops by 40% because you have to reinvest at the lower rate.

Solution: This is why the Bond Laddering Strategy is critical—it ensures you don't reinvest all your money at the worst possible time.

📚 Official Sources & Regulations