If you have money in a bond fund or if you own a bond, you should pay close
attention to an important number known as duration. This will signal the
likely change in the price of your bond when interest rates either go
up or go down – the higher the number, the more your investment
will likely react to market changes.
If you have invested in outstanding bonds, especially ones with a high
duration and low interest rate, the price could drop from time to time
as interest rates go up, and the value of bond funds that mostly hold
primarily long-term bonds are also likely to drop over time as interest
rates go up.
How Price Is Affected By Duration Risk
While a number of factors can affect the prices of bonds and bond funds,
changes in interest rates are among the most important to monitor. It’s
a well-known fact among the investment community that any time interest
rates go down, bond and bond fund prices go up, and when rates go up prices
go down. However, not all bonds and bond funds react the same way to changes
in interest rates – some will react more dramatically than others,
which is why the duration is so important.
The lower a bond or bond fund’s duration, the less sensitive it is
to changes in interest rates which means that changes in price, whether
they are positive or negative, will not affect your investment as much
as one with a high duration. As long as the company keeps paying interest
to bondholders, holding your bond to maturity likely means that you will
receive the face value of your investment when your principal is repaid.
However, selling your bond or bond fund before it reaches maturity means
that the price you receive will be affected by the duration and interest rates.
Calculating the duration includes factors like the amount of time it takes
for the bond or bond fund’s principal to be repaid, changes in credit
quality, yield and call features. However, just because your bond or bond
fund has a low duration doesn’t mean that you’re safe from
risk. You should always speak with your financial adviser about any investments
you are considering, and if you believe that your financial adviser misled
you, provided false information, or committed any other type of misconduct,
speak with one of our investment fraud attorneys at Meyer Wilson to discuss
your case today.