Understanding Your Bond Fund’s Duration (2024)

FAQs

Understanding Your Bond Fund’s Duration? ›

The longer a fund's average effective duration, the more sensitive the fund is to shifts in interest rates. In other words, if rates move up by 1 percentage point, the price of a bond with a duration of 5.0 years will move down by 5%, while a bond with a duration of 10.0 years will move down by about 10%.

As the table below shows, the shorter a bond's duration, the less volatile it is likely to be. For example, a bond with a one-year duration would only lose 1% in value if rates were to rise by 1%. In contrast, a bond with a duration of 10 years would lose 10% if rates were to rise by that same 1%.

Effective duration calculates the expected price decline of a bond when interest rates rise by 1%. The value of the effective duration will always be lower than the maturity of the bond.

Generally, the higher a bond's duration, the more its value will fall as interest rates rise, because when rates go up, bond values fall and vice versa.

Duration and Risk

We observe that duration is increasing with maturity: the duration of a 5-year note is 4.0 years, and that of a 30-year bond is 11.3 years.

Bond duration is a fundamental concept in fixed-income investing. It measures the sensitivity of a bond's price to changes in interest rates by calculating the weighted average time it takes to receive all the interest and principal payments. The longer the duration, the greater the interest sensitivity.

Duration measures a bond's or fixed income portfolio's price sensitivity to interest rate changes. Most often, when interest rates rise, the higher a bond's duration, the more its price will fall. Time to maturity and a bond's coupon rate are two factors that can affect a bond's duration.

If you have a very short-term time horizon (less than 1 year), you may want to stick with money market funds or a very short-term, high-quality bond fund that attempts to minimize share price fluctuation. If you have at least a year before you'll need the money, consider a short-term bond fund.

2022 was the worst year on record for bonds, according to Edward McQuarrie, an investment historian and professor emeritus at Santa Clara University.

Bond duration measures a bond's sensitivity to interest rate changes, indicating its price volatility. To calculate: Multiply each cash flow by the time until receipt, then divide the sum of these products by the bond's current price.

What happens to a bond fund when interest rates rise? ›

Bond prices have an inverse relationship with interest rates. This means that when interest rates go up, bond prices go down and when interest rates go down, bond prices go up.

As the table below shows, the shorter a bond's duration, the less volatile it is likely to be. For example, a bond with a one-year duration would only lose 1% in value if rates were to rise by 1%. In contrast, a bond with a duration of 10 years would lose 10% if rates were to rise by that same 1%.

Should I only buy bonds when interest rates are high? There are advantages to purchasing bonds after interest rates have risen. Along with generating a larger income stream, such bonds may be subject to less interest rate risk, as there may be a reduced chance of rates moving significantly higher from current levels.

Series EE savings bonds are a low-risk way to save money. They earn interest regularly for 30 years (or until you cash them if you do that before 30 years). For EE bonds you buy now, we guarantee that the bond will double in value in 20 years, even if we have to add money at 20 years to make that happen.

Duration is a measure of how much the price changes as a result of this risk. Changes in interest rates do not affect all bonds equally, however. Generally, the longer the maturity of the bond, the more its price will be affected by interest rate changes.

Modified duration, a formula commonly used in bond valuations, expresses the change in the value of a security due to a change in interest rates. In other words, it illustrates the effect of a 100-basis point (1%) change in interest rates on the price of a bond.

general: Changes in the value of a bond are inversely related to changes in the rate of return. The higher the rate of return (i.e., yield to matu- rity (YTM)), the lower the bond value.

A higher duration implies greater price volatility should rates move. Duration is quoted as the percentage change in price for each given percent change in interest rates. For example, the price of a bond with a duration of 2 would be expected to increase (decline) by about 2.00% for each 1.00% move down (up) in rates.

Duration is expressed in terms of years, but it is not the same thing as a bond's maturity date. That said, the maturity date of a bond is one of the key components in figuring duration, as is the bond's coupon rate.