In an Investor Alert released on February 14, 2013, FINRA warned investors that if interest rates rise as expected, bond holders will be “slammed” with long duration. It stated that “in the event of rising interest rates, outstanding bonds, particularly those with a low interest rate and high duration, may experience significant price drops.”
Duration, in this context of bond funds, refers to the value of a bond. Duration signals how much the price of an investor’s bond investment is likely to fluctuate when there is an up or down movement in interest rates. The higher the duration number, the more sensitive an investor’s bond investment will be to changes in interest rates. Bonds with high duration lose value when interest rates rise.
The alert warns that bond funds with 10-year durations will decrease in value by 10% if rates rise one percentage point. Investors should look at the fund’s fact sheet, check with their investment professional, the bond’s issuer, or use an online calculator to get the duration figure.
However, the alert also states that “short duration doesn’t mean risk-free…bonds and bond funds are subject to inflation risk, call risk, default risk and other risk factors.”