A client came to me last week with a puzzled expression. "Everyone keeps telling me to invest in bonds now that interest rates are good," he said, "but nobody explains what kinds to choose." His confusion reminded me of my early days as an investor when I thought all bonds were essentially the same. That misconception cost me some good opportunities.

After two decades working with fixed income securities, I've come to appreciate the rich variety of bonds available in the Indian market. Let me walk you through the main types of bonds you should know about before making investment decisions.

Government Securities: The Gold Standard

Government bonds, often called G Secs, are issued by the Reserve Bank of India on behalf of the government. I remember my father calling them "worry free investments" and there's truth to that.

When I first started to invest in bonds seriously around 2007, I put about 40% of my fixed income portfolio in G Secs. Their biggest advantage? Zero default risk since they're backed by the government itself.

They come in various tenures ranging from short term Treasury Bills (91 days, 182 days or 364 days) to long term dated securities (up to 40 years). The returns are typically lower than other bonds, but the safety is unmatched.

Last year, my risk averse brother finally moved some money from fixed deposits to 10 year G Secs when yields crossed 7.5%, a decision that has already paid off nicely for him.

Public Sector Undertaking Bonds: The Middle Ground

PSU bonds are issued by government owned companies like NTPC, PFC, REC and others. They typically offer slightly higher yields than G Secs while still providing strong safety.

I've always liked PSU bonds for their balance of decent returns and relative safety. When my daughter's education fund needed growing with minimal risk, I allocated a good portion to AAA rated PSU bonds offering about 0.5% to 1% more than government securities.

One advantage that helped me once during a cash crunch is their better liquidity in the secondary market compared to private corporate bonds. I was able to sell some IRFC bonds quickly when I needed funds for a family emergency.

Corporate Bonds: Higher Yields With Higher Risk

Private companies also issue bonds to raise capital, offering higher interest rates to compensate for the increased risk. The range here is vast, from ultra safe AAA rated large company bonds to much riskier lower rated issues.

My first experience with corporate bonds taught me a valuable lesson. Back in 2009, I was tempted by a BB rated bond offering nearly 12% when most AA bonds were around 9%. Fortunately, my mentor warned me to stick with quality for most of my portfolio. That particular company later faced severe financial difficulties.

Now I follow a personal rule: I only invest in bonds rated A or above for at least 80% of my corporate bond allocation.

A friend who ignored this approach lost nearly 30% of his investment in a lower rated bond that defaulted. Remember, when you invest in bonds from private companies, you're essentially lending them money based on their promise to repay.

Tax Free Bonds: For the Tax Conscious

These special bonds are issued by government entities like NHAI, REC, IRFC and others. While their pre tax yields seem lower, the tax exemption on interest makes them extremely attractive for investors in higher tax brackets.

I still hold some tax free NHAI bonds issued in 2013 that offer 7.14% tax free returns. For someone in the 30% tax bracket, that's equivalent to a taxable bond yielding over 10%! Unfortunately, fresh issues of tax free bonds have become rare, making secondary market purchases the only option now.

State Development Loans: The Overlooked Option

SDLs are issued by state governments and typically offer slightly better yields than central government securities with nearly comparable safety.

I was introduced to SDLs by a retired banker in 2018 and have since included them in my portfolio. They typically offer 0.4% to 0.7% higher yields than G Secs of similar tenure, which adds up significantly over long holding periods.

Inflation Indexed Bonds: Protection Against Rising Prices

These specialized bonds adjust their principal amount based on inflation rates, protecting your investment from losing purchasing power. While relatively new to India, they serve an important role in a comprehensive portfolio.

During the high inflation period of 2013 to 2014, I allocated about 10% of my bond portfolio to inflation indexed bonds, which proved to be a smart move as inflation crossed 9% briefly.

The Bottom Line

When you decide to invest in bonds, remember that different types serve different purposes. I generally recommend a mix based on your goals, risk tolerance and tax situation.

For safety and stability, start with government securities. Add some PSU and high rated corporate bonds for better yields. If you're in a higher tax bracket, hunt for tax free bonds in the secondary market. And consider a small allocation to inflation indexed bonds as a hedge.

The types of bonds you choose should reflect your personal financial situation. Just as I wouldn't recommend the same diet to everyone, I wouldn't suggest the same bond portfolio to all investors. Take time to understand these options, and you'll be better equipped to make fixed income investments that truly serve your financial goals.