How reinvestment risk in debt mutual funds can hit your returns

One of the risks that investors in debt instruments face is reinvestment risk, as a result of fluctuating interest rates in the debt markets. When coupon interest on a bond held is received periodically or when the principal amount is received on maturity, the money has to be reinvested at the interest rate prevailing in the market at that time. The rate may be higher or lower or the same level as the interest rate on the original bond. If the interest rate is lower than that of the original bond, then the coupon interest and principal amount received are reinvested at the lower rate. This risk is known as reinvestment risk in bond investments.

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