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, you should speak with one of our investment fraud attorneys at Meyer Wilson to discuss your case today.