Duration Uses – Long Duration = Higher Risk

WSJ: Don't Trip in Your Search for Higher Bond Yields

Last month, investors put twice as much money into intermediate-term and junk-bond funds as into short-term bond portfolios. As a result, they have exposed themselves to much greater risk from rising rates or falling credit quality. When interest rates go up, as in 1994, investors in longer-term bonds can get slaughtered.

"People feel they have to choose between the frying pan of zero yields and the fire of risk," said Crane Data's president, Peter G. Crane. "And they're sick of the frying pan, so they're jumping into the fire."

Bonds are safer than stocks. But, at today's high prices and low yields, bonds are riskier than they were a few months ago. The easiest way to tell is by looking at duration: the change in a bond's market value when interest rates go up or down by one percentage point. If, for example, you own a bond with a duration of four, then its value will go up about 4% if interest rates fall by a percentage point; the bond will lose about 4% if rates rise by one point. For Treasury bonds, rising interest rates are the main form of risk; for corporate, municipal and other bonds, the financial soundness of the underlying assets raises another kind of risk.

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