Definition
Duration estimates a bond or bond fund's price sensitivity to a change in interest rates. An ETF with a duration of 7 years would be expected to lose roughly 7% if comparable yields rose by one percentage point, or gain roughly 7% if yields fell by one point. That is an estimate, not a promise, because large rate moves and changing credit spreads make the relationship nonlinear.
Duration is not the same as maturity. Maturity says when principal is due; duration also accounts for when coupons arrive. Higher coupons return cash sooner and usually reduce duration.
Why It Matters
A bond ETF can have a modest yield and still carry substantial price risk. Duration lets investors compare that risk before assuming every bond fund is a stable cash substitute. It also helps match a holding to a time horizon: money needed soon generally should not depend on long-duration prices.
Example
Suppose a bond ETF has an effective duration of 6.5 years. If market yields rise from 4% to 4.75%, the duration estimate is -6.5 × 0.75%, or about a 4.9% price decline. Income continues to arrive, and the fund gradually reinvests at higher yields, but the immediate price effect matters.
Common Mistakes
- Treating maturity and duration as interchangeable.
- Assuming a bond ETF cannot lose money because its holdings eventually mature.
- Comparing yields without comparing duration and credit quality.
- Using the estimate as an exact forecast for a large rate move.
FAQ
Is lower duration always better?
No. Lower duration reduces rate sensitivity, but longer duration can provide more upside when rates fall and may better match a long-dated liability.
Does duration include credit risk?
Not fully. Duration isolates rate sensitivity; changing credit spreads can move corporate bonds in addition to the Treasury-rate effect.
