Buying bonds? These 5 mistakes could be quietly increasing your risk

For decades, the ordinary Indian investor has used two channels of investment: fixed deposits for safety and real estate or gold for compounding growth. Bonds have been structurally out of reach, not because of their unsuitability, but because the corporate bond market was built and designed for institutions. The minimum ticket size ran into lakhs and the awareness gap among investors was minimal. Most investors in the country were aware of their fixed deposit rates but they did not know that they would be able to earn the same money in a bond issued by the institutions the government itself backs.

With around 30 SEBI-registered online bond platforms now operating, an investor with a demat account can browse and buy listed corporate and government bonds for a minimum of about ₹10,000, much as they would buy shares. Many people who previously held only fixed deposits and equity mutual funds are now beginning to add bonds to the mix.

This is a welcome development as bonds can offer relatively stable income and bring balance to an investor’s portfolio. But they work differently from both deposits and equities, and several of their risks are less visible than the daily price movements of the stock market. As more individual investors take part, a few common mistakes are worth understanding in advance.

Focusing on yield alone

A higher yield is not simply a better deal. In most cases, it reflects higher risk. The additional return a bond offers over a government security of similar maturity is, broadly, the market's assessment of the chance that the issuer may not pay in full or on time. When comparing two bonds, it helps to understand why one offers more than the other, rather than choosing on the headline rate alone. A yield that looks unusually attractive is usually attractive for a reason worth examining.

Concentrating in one issuer or sector

Holding several bonds is not the same as being diversified. If most of them are issued by companies in the same industry, such as non-banking finance companies or firms lending to a single part of the real estate market with the portfolio being effectively exposed to the same set of risks more than once. India has seen periods in which difficulties at one large issuer were quickly felt across others in the same sector, because they depended on similar sources of funding. Spreading investments across different industries and types of issuers offers more genuine protection than simply holding a larger number of bonds.

Depending only on the credit rating

Credit ratings are a useful guide, but they have limits. A rating is an opinion formed at a particular point in time and reviewed periodically; it may not reflect the issuer's current position, and ratings can be revised downward quickly when conditions change. Rather than treating the rating as the final word, it helps to look at the issuer itself - how it earns the money to repay, how much it has already borrowed, and whether it faces large repayments in the near future that it will need to refinance. The rating is a starting point and not a substitute for understanding the borrower.

Not matching maturity to goals

Every bond has a maturity date, and that date matters as much as the interest it pays. Investing in a long-dated bond for a goal that is only a few years away can create difficulties, because selling before maturity may mean accepting a loss, particularly when interest rates have risen. It also helps to understand exactly what is being bought: some instruments, such as the perpetual or additional-tier-one bonds issued by banks, carry features and risks quite different from an ordinary fixed deposit, even when the return looks similar. Choosing bonds whose maturities line up with when the money will actually be needed is a simple but important discipline.

Assuming a bond can always be sold easily

Many investors assume a bond can be sold whenever they want, the way a stock usually can. In practice, the secondary market for many corporate bonds in India is thin, especially for lower-rated issues. A ready buyer may not be available, and selling before maturity can mean accepting a price below fair value. It is sensible to invest on the assumption that a bond may need to be held until it matures, and to be comfortable with that possibility before buying.

None of this is a reason to avoid bonds. Used with a little care, they are a valuable and stabilizing part of a well-constructed portfolio, and the recent improvement in access is good news for individual investors. The essential point is that a bond is not simply a higher-paying deposit. Understanding what the yield reflects, spreading risk across issuers and sectors, looking beyond the rating, matching maturities to goals, and allowing for limited liquidity together make the difference between using bonds well and being caught out by risks that were there all along.