What is Bond Duration and What Does it Mean to You?


February 22, 2011
Written by: Justin Russell

There has been much discussion of late regarding interest rates. The historically low interest rate environment that we are in comes with positives such as low rates on mortgages, home equity lines, vehicle loans, margin loans and personal loans. The flip side of these positives is that consumers have paid next to nothing on deposits in checking or savings accounts with banks and credit unions. For the consumer, the conversation on interest rates generally centers on these positives and negatives. An often overlooked aspect of interest rates is the effect they will have on your investment portfolio. A helpful tool in answering that question is a measurement called duration.

Duration is defined as "the weighted average maturity of a bond or series of cash flows received." It makes perfect sense now, right? In simple terms, duration is how long it takes you to get paid back on a bond. Duration is extremely helpful in quantifying how interest rate movement will affect your portfolio. For every 1% increase in interest rates, a bond will move down by its duration. For example, a bond with a duration of 5 years will move down 5% for every 1% rise in interest rates. As you can see, the higher the duration of a bond, the more sensitive that bond is to movements in interest rates.

Interest rates are currently at historically low levels, but that won't always be the case. As we near the point where rates begin to rise, it is important to make sure your portfolio is positioned accordingly.

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