Maturity vs. Duration / Making Sense out of Bonds and Bond Funds

When you first look at a bond or bond fund they have all of these terms. Maturity, Yield to Maturity, Duration, Yield to Call, etc. These bond terms are confusing to the new investor. Today we are going to look at the terms Maturity and Duration. What are the differences? Why they don’t mean what you might THINK they mean.

Duration vs. Maturity with Bonds

When someone sees the term Duration they automatically focus on the length of time. However, with bonds, this is not exactly right.

Duration measures the SENSITIVITY of a bond to interest rates.

The longer the duration, the more sensitive it is to interest rate increases or decreases. Sensitivity changes with the market over time. The duration of a bond is NOT a constant.

On the other hand, Maturity is a CONSTANT over the life of a bond. For example, if you buy a 13 week Treasury Bill. The maturity is 13 weeks from the date you own the bond. That date never changes regardless if the interest rates move up or down by 5% (or more). The maturity of that bond is always 13 weeks. So, think CONSTANT when you see the word Maturity.

Now for an example to clarify further:

Suppose we have two bonds. One with a duration of 5 years and another with a duration of 3 years. Which one is more sensitive to interest rates? The five year bond. Remember, longer duration = more sensitive to interest rates. If the interest rates increase by 2%, we would expect the bond with a duration of 5 years to drop in value more than the 3 year duration one.

In summary, if you believe we are entering an economic environment where rates are going to rise or drop sharply, then you wouldn’t want to purchase bonds with long durations (At least not if your investment horizon was anywhere in the near future). If your time horizon is long enough and you plan to hold long-term bonds to maturity, then you probably don’t need to worry about this stuff.

How can you use this information?

The next time you look at a bond fund, check out the Duration. Compare one bond fund to another to determine how volatile the price might be in a rising or falling interest rate environment.

Here is one of my favorite Bond Funds, SCHR

The current duration is 5.2 years. Meanwhile, the effective duration on the long-term bond fund TLT is 17.3 years. Therefore, we conclude that TLT is much more sensitive to interest rate changes than SCHR (Hence why it is down over 30% this year!).

I will end by saying this, if you intend to hold a bond or bond fund to maturity then things like duration matter a lot less to you. When held to maturity you should get your principal back. We will talk more on matching maturity to liability later on.

WISHING YOU THE BEST WITH YOUR INVESTING!

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