Reader challenge: Can you explain duration better than The New York Times?
The duration of a bond isn’t easy to explain in few words
. This is why I was delighted by the brief description I found in The New York Times.
Author Carla Fried wrote, “For the most part, managers seem to agree that it is best to limit a fund’s duration, or sensitivity to changes in interest rates. The longer the duration, the more yield you get today, but with the trade-off of a bigger price decline if rates rise.” This paragraph appeared in “Tiny Yields Pose Risks for Bond Funds” on July 8, 2012.
Can YOU explain duration better?
I’m interested in alternative explanations of duration that an ordinary American can understand. Please leave your suggestions below.
I recall coming across this definition of duration: The amount of time one must hold onto the bond in order to receive the quoted yield to maturity.
Thank you, James!
In terms of what average investors might understand, bond managers tend to be “short duration” when they don’t want to commit long-term to current rates, which they may expect to rise sooner than later. Similar to buying a short term CD with a low yield because you want to be ready to buy a higher yield as soon as it’s available, which you can’t do if you are tied up with a lower long-term rate and a penalty for early withdrawal.
Thanks, David!
Excellent definition; thanks for making it available! I like that it goes beyond yield to maturity to include questions of strategy. Stating that connection in plain language has always eluded me.
Someone unfamiliar with the rate/price relationship might need explanation of why “the bigger price decline if rates rise,” but that’s much easier than tackling the entire concept of duration.
Glad you liked it, Susan! It’s hard to pack a robust explanation of duration into a limited number of words.