Bond Duration Explained: How to Estimate What a Rate Change Does to Your Bond Fund, With Worked Examples

One number on your bond fund's fact sheet can tell you roughly how much it may gain or lose when interest rates move. Here is how to read it and use it.

What is bond duration?

Bond duration is a measure of how sensitive a bond's price is to changes in interest rates. It is stated in years. As a rule of thumb, a bond or bond fund with a duration of 5 years would lose about 5% of its value if rates rose 1 percentage point and gain about 5% if they fell 1 point.

That rule of thumb comes straight from Fidelity's guide to duration, which says a bond or bond fund with a 5-year average duration "would likely lose approximately 5% of its value" if rates rose 1%. Vanguard's bond basics page describes duration the same way: a measure of a bond's sensitivity to changes in interest rates, measured in years.

Duration rolls several features of a bond into one number, including how long until it matures and how much interest it pays along the way. That is what makes it handy. Instead of comparing maturity dates, coupon rates and payment schedules across dozens of bonds, you can compare one figure. A fund with a duration of 2 is far less sensitive to rate moves than a fund with a duration of 15.

Duration is not the same as maturity, even though both are measured in years. Fidelity points out this difference directly. A 10-year bond that pays interest every six months has a duration shorter than 10 years, because you collect part of your money back before the final payment. The more interest a bond pays before it matures, the shorter its duration tends to be.

Why do bond prices fall when interest rates rise?

The U.S. Securities and Exchange Commission calls this a fundamental principle of bond investing. In its investor bulletin on interest rate risk, the SEC says market interest rates and bond prices generally move in opposite directions: when rates rise, prices of fixed-rate bonds fall.

Here is the simple reason. Say you own a bond that pays 3% a year. If new bonds start paying 4%, nobody will pay full price for your 3% bond when they can buy a 4% bond instead. For your bond to find a buyer, its price has to drop until its overall return roughly matches the new 4% rate. When rates fall, the reverse happens, and older bonds with higher payments become more valuable.

Duration measures how big that price adjustment is. A bond that pays you back slowly, over many years, has more of its value tied up in distant payments. Those distant payments are hit harder when rates change, so the bond's price moves more. That is why long-term bonds and long-term bond funds swing more than short-term ones. Readers who want the basics first can start with our guide to how bonds and Treasuries work.

The SEC bulletin adds two related points. First, longer maturities mean more risk that a bond's value will be hit by rate changes before it matures. Second, if two bonds are alike except for their coupon rates, the one with the lower coupon generally loses more value when rates rise. Both points fit duration: longer maturities and lower coupons both push duration up.

How do you use duration to estimate a price change?

The basic math is short. Multiply the fund's duration by the change in interest rates, in percentage points, and flip the sign. Rates up means the price goes down, and rates down means the price goes up.

Estimated price change = minus duration times the change in rates.

Worked example 1: a core bond fund. Say you own $20,000 of a bond fund with a duration of 6 years, and rates rise by half a percentage point, or 0.5. The estimate is 6 times 0.5, which is 3. So the fund's price could fall about 3%, or roughly $600 on $20,000. If rates instead fell by 0.5 points, the same fund could gain about 3%, or roughly $600.

Worked example 2: short-term versus long-term. Now compare two funds after a 1-point rise in rates. A short-term fund with a duration of 2 years would drop about 2%. A long-term fund with a duration of 16 years would drop about 16%. On $10,000, that is about $200 for the short-term fund versus about $1,600 for the long-term fund. Same rate move, very different results.

Worked example 3: a small daily move. Bond yields often move by a few hundredths of a percentage point in a day. Traders measure these moves in basis points, where one basis point is one-hundredth of a percentage point. If yields rise by 3 basis points, or 0.03 points, a fund with a duration of 6 would fall about 6 times 0.03, or 0.18%. On $10,000, that is about $18. This is the kind of move we described after October's strong jobs report pushed Treasury yields higher.

You can usually find a fund's duration on its fact sheet or on the fund company's website. Fidelity, for example, lists it among a fund's portfolio data. Some fund companies call it "average duration" or "effective duration." For a quick estimate, either works.

How accurate is the duration rule of thumb?

It is an estimate, not a promise. Fidelity notes that its duration math "is an approximation that ignores the impact of convexity," and that duration may be less useful for large rate changes. Convexity is the fact that the link between bond prices and rates is curved rather than a straight line. For ordinary bonds, that curve works slightly in the owner's favor: prices tend to fall a little less than duration predicts when rates rise, and rise a little more when rates fall.

The SEC's own example shows this clearly. It describes a 10-year Treasury bond with a 3% coupon and a $1,000 face value. One year later, with nine years left, its price is about $925 if market rates have risen to 4%, and about $1,082 if rates have fallen to 2%.

We can check that against duration. By our calculation, a 9-year bond paying 3% twice a year, priced at $1,000, has a modified duration of about 7.8. Duration alone would predict a price near $922 after a 1-point rise and near $1,078 after a 1-point fall. The actual prices in the SEC example, $925 and $1,082, are a bit better in both directions. That small gap is convexity at work. For a 1-point move, duration gets you within about half a percent of the price. For much larger moves, the gap grows.

Duration also assumes all rates move together. In real markets, short-term and long-term yields often move by different amounts. A fund holding mostly long bonds may react differently than its single duration number suggests if only short-term rates jump. And for bonds with credit risk, such as corporate or high-yield bonds, prices can also move because investors worry about defaults, which duration does not capture.

Does duration matter if I hold a bond until it matures?

Less so for an individual bond. Vanguard notes that if you hold a bond to maturity, price swings generally won't matter, since your interest payments and face value won't change, assuming the issuer pays as promised. The SEC makes the same point: if you plan to hold a bond to maturity, day-to-day price changes may matter less, because you will still receive the stated interest and the face value at maturity.

There is a catch. The SEC also warns that the U.S. government does not guarantee the market price of a Treasury bond if you sell it before it matures. If you need the money early, you take whatever the market will pay that day, which could be less than you paid.

Bond funds are different. Most bond funds never mature. They keep buying new bonds as old ones mature or get sold, so the fund keeps a fairly steady duration over time. That means a bond fund's price can stay lower for a while after rates rise. The good news is that the fund also starts buying newer bonds that pay the higher rates, so its income tends to rise over time.

That leads to a useful way to think about duration: it is roughly the number of years it takes for higher income to make up for a price drop. Take a fund with a duration of 6 and a yield of 4%. If rates jump 1 point, the fund could lose about 6% in price. But it would then be reinvesting at roughly 5%, so it earns about 1 point more a year than before. Over about six years, that extra income adds back roughly 6 points. This is a simplified picture, and real results depend on what rates do next, but it shows why investors often try to match a bond fund's duration to how long they plan to hold it.

How can investors use duration in their own plans?

Duration is most useful as a way to match your bonds to your timeline. Money you may need within a year or two is often kept in cash, Treasury bills or short-duration funds, where a rate jump does little damage. Money you will not touch for many years can, for some investors, sit in longer-duration bonds, which pay more when rates are high but swing more along the way. Neither choice is right for everyone, and duration does not tell you which way rates will go.

It also helps to know what you own. Many 401(k) plans offer a broad "core" or "total bond" fund, and many target-date funds hold a mix of bonds. Checking the duration of those funds tells you how much they may move if rates rise or fall by a point. If you see a duration of 6, you know a 1-point rise could cost about 6% on that slice of your money, and a 1-point drop could add about 6%.

Finally, duration helps explain why bonds and stocks do not always balance each other. Our guide to stocks versus bonds covers why many people hold both. When rates rise quickly because inflation is high, both can fall at the same time, and long-duration bonds can fall the most. Knowing your fund's duration will not prevent that, but it can keep a bad month from being a surprise.