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What is Duration, and Why Should I Pay Attention to It?

Published Saturday, July 5, 2014 12:03 am

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2013 for use by Evan R. Guido

 

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The Federal Reserve's actions over the next year could be important to bond markets, particularly if and when the Fed decides to increase its target interest rate. Since bond prices typically move in the opposite direction from yields, rising bond yields will translate into a decline in bond prices.

 

If you have bonds or bond mutual funds in your portfolio, you might want to pay attention to the duration of each one. Technically, a bond or bond fund's duration calculates the length of time it will take to receive the full true value of the investment; duration takes into account the present value of expected future payments of interest and principal.

 

However, duration's biggest value to an investor is as a gauge of how sensitive a bond might be to changes in interest rates. The longer a bond's duration, the more its price is likely to be affected by an interest rate change. A mutual fund's duration can be found in its prospectus; for an individual bond, you'll probably need to ask your broker or the bond's issuer.

 

To estimate the impact of an interest rate change on a specific bond holding, simply multiply its duration by the change in interest rates. For example, for a bond fund with a duration of 5 years, a 1% increase in interest rates would generally result in a 5% drop in the fund's value (1% x 5 years = 5%). Though the Fed's target rate is already at its historic low, the same principle would apply in reverse if interest rates were to fall. A 1% decline in interest rates would likely result in a 3% gain for a bond holding with a duration of 3 years.

 

Note: These hypothetical examples are intended as an illustration only and do not reflect the performance of any specific investment. They should not be considered financial advice. Before investing in a mutual fund, consider its investment objective, risks, fees, and expenses, which can be found in the prospectus available from the fund. Read the prospectus carefully before investing.

 

Bear in mind that duration can work somewhat differently for specific types of bonds--for example, floating-rate bonds whose interest payments get reset. That's also true for mortgage-backed bonds, since interest rate changes can cause homeowners to refinance their loans.

 

See also:

At What Age Should You Take Your Social Security?

 

Got Questions? Ask Guido 

 

 

Evan R. Guido

Vice President of Private Wealth Management

One Sarasota Tower, Suite 1200

Two North Tamiami Trail

Sarasota, FL  34236-4702

941-906-2829 Direct Line

888 366-6603 Toll Free

941 366-6193 Fax

www.EVANGUIDO.com

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Obituaries

Name Date
Edith Norbury July 20, 2014
Richard McLaren July 17, 2014
Jean Burroughs July 18, 2014
Larry Van Winkle July 18, 2014
Eugenia Shannon July 15, 2014
Philip Hack May 28, 2014
Melvin White July 5, 2014
Judith Kissel July 8, 2014
Abbott Siplin July 19, 2014
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