Bond Duration: Measuring Interest Rate Risk In Your Portfolio
Bond duration is a good indicator of how much interest rate risk you have in your bond portfolio. In simple terms, “duration” is the mid-point at which an investor receives half the present value of their original investment back from a bond. Ten-year Treasury Bonds issued in 1980 with a yield of 15% had a much lower duration than the 10-year Treasury Bonds issued today that pay a measly 0.7%. The duration is lower because you get more of your investment back earlier than you do today. Keep in mind that bond prices move opposite of interest rates. When interest rate rise, bond prices fall. A duration of 10 means that a bond (or if it is the average duration for a bond portfolio) will lose principal value of 10% if interest rates rise by 1%. In today’s low interest rate environment (at a time of rapidly rising money supply), it is important to understand the risk to your bond portfolio if interest rates rise. At THOR, we currently have a lower duration today than the general bond market because we see more risk in interest rates rising in the future than falling.