Which kind of loss is usually temporary?

A fall caused by rates rising, because the bonds still mature at their face value

What does a longer Macaulay duration tell you?

The fund's value moves more when interest rates move

The fund holds riskier borrowers

You have to stay invested for that many years

Lesson 1 of 3 · 8 min

Two risks, and they are unrelated

A bond fund can lose money two entirely different ways. Knowing which one a fund is exposed to is most of what there is to understand about it.

People put money in a debt fund because someone told them it was the safe one. Then a month comes where the number goes down, and nobody explained that it could. It can, for two reasons that have nothing to do with each other, and a fund can be heavily exposed to one while carrying almost none of the other.

The distinction matters because the two behave differently. Interest-rate losses are usually temporary — hold the bonds to maturity and you get the promised amount back. A default is not temporary. Money that does not arrive does not arrive later. So two funds that both fell 3% last quarter may be in completely different situations, and the fall alone does not tell you which.

The same fall, two different causes

One number tells you about the first risk and a different number tells you about the second. Neither tells you about both.
Question	Rates rose	A borrower defaulted
What happened	Existing bonds are worth less at today's rates	An issuer failed to pay
Does it reverse?	Usually, as the bonds approach maturity	No. The money is gone
What makes it worse	Longer duration in the portfolio	Lower-rated borrowers in the portfolio
Where you can see it coming	The fund's Macaulay duration	The fund's credit quality

So which risk should I avoid?

KabirTara

Kabirasking
This sounds like credit risk is the dangerous one. Should I just stay away from anything with it?
Taraexplaining
That is a decision, and it depends on things this page cannot know — when you need the money, what else you hold, how a bad quarter would affect you. What the page can do is make sure you know which risk you are taking.
Kabirasking
But surely more risk is just worse.
Taraexplaining
It is worse if you did not know it was there. The failure mode people actually hit is not choosing risk — it is being told a fund was safe, meeting a risk nobody named, and selling at the bottom because it felt like a betrayal.

Quick check

A fund holds only government securities with a long average duration. Which risk is it mostly exposed to?

Check yourself

1 / 3

Kabir asks

What are the two risks a debt fund carries?

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