Bond duration
A measure, in years, of how sensitive a bond or bond fund’s price is to changes in interest rates.
What it means
Duration summarizes interest rate risk in one number. Technically it is the weighted average time until a bond’s cash flows are received, but in practice investors use it as a rule of thumb: for each 1 percentage point change in yields, a bond’s price moves by roughly its duration in percent, in the opposite direction.
Longer maturities and lower coupons mean higher duration and bigger price swings; short-term bonds have low duration and move less. Bond funds report an average duration, which is often more useful than average maturity. The rule is an approximation that works best for small rate changes, and holding an individual bond to maturity still returns its face value if the issuer pays.
Formula
% change in price ≈ −duration × change in yield
- Duration = the bond or fund’s duration in years
- Change in yield = the change in interest rates, in percentage points
Example
Suppose a bond fund has a duration of 6 years and yields rise by 1 percentage point. Its price would fall by about 6 × 1 = 6%, so a $10,000 position would drop to roughly $9,400. If yields fell 1 point instead, it would rise about 6%.
How it’s used
- Comparing the interest rate risk of bond funds
- Matching bond holdings to when money will be needed
- Estimating how a portfolio might react to rate changes
Good to know
- Money needed in the next year or two is usually exposed to less rate risk in short-duration bonds or cash.
Related terms
Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.