The Importance of Duration When Buying Bonds

Equity market volatility drives some investors out of stocks and into bonds, which are often perceived to be less risky. Certainly, bonds do not have the same kind of risk equities have.

But bonds also have risks, and perhaps the greatest such risk is interest rate risk. This risk can be managed by looking at something called duration.

First, it is important to understand how bond prices work. Typically, bond prices move in the opposite direction of interest rates. Higher interest rates drive bond prices down, and lower interest rates drive bond prices up.

The risk that your bond price will fall because interest rates rise is called interest rate risk. And when purchasing shares of a bond fund, you can help manage this interest rate risk by paying attention to the fund’s duration.

Duration may sound complicated, but it is just a number that indicates the percentage change in the price of a bond fund for each 1 percent change in interest rates. So, if the bonds in a particular fund have an average duration of five years, for each 1 percent change in interest rates, the bond fund’s price should move 5 percent in the opposite direction.

The lower the average duration of a bond fund, the less price sensitivity the bond should experience. So, if you are a risk-averse investor, you may want to consider bond funds with shorter durations.

It is typically easy to obtain this information from a bond fund’s website or prospectus. You can also ask us. Feel free to contact our office with any questions about bond investing.