# What Is the Duration of a Bond?

Share

Whether you take an aggressive or conservative approach to invest, your asset allocation is likely to include some bonds. When reading about or researching bonds, you’ll hear about duration, an important metric that measures the time it will take for you to receive back a bond’s price from the cash flows it produces.

## What Is Duration? Definition and Examples

Duration is a figure that represents the time that it will take for you to receive the equivalent of a bond’s price in the form of coupons. It’s measured in years, with a longer duration meaning that it will take longer for you to earn those coupons. All things being equal, a bond’s duration will decrease as it matures.

In practical terms, investors care about duration because it also indicates how sensitive a bond’s price is to changes in interest rates. It helps investors to predict how much they will make (or lose) as bond prices change with inflation. A bond’s price and duration have an inverse relationship. If one goes up, the other goes down.

As a simple example, let’s say you have a bond with a duration of five years. If interest rates increase by 1%, the bond’s price will decrease by 5%. If interest rates somehow increase by 2%, the same bond’s price would decrease by 10%. And if you have a bond with a duration of five years and the interest rate decreases by 1%, then the bond’s price will increase by 5%.

The exact calculations behind the duration are a bit complex. Thankfully, though, you don’t need to know them to understand why the duration is useful.

What makes the conversation around duration even trickier is that there are really two types of duration. Macaulay duration measures how long it will take for you to receive payouts equivalent to a bond’s price, and modified duration measures the sensitivity of a bond’s price to changes in interest rates. People commonly confuse the two types.

## How Duration Interacts with Bond Prices

Duration is valuable when you are looking to buy or sell bonds or bond mutual funds on the market. To understand why, it’s important to talk about what a bond’s par value and price are.

Par value is the face value of a bond. If you buy a \$1,000 bond, the par value is \$1,000 and you will receive \$1,000 when the bond reaches maturity. Par value does not change during the term of a bond, no matter what market interest rates or bond prices do.

When people refer to the price of a bond, they are referring to its market value. Much like stocks and other securities, the market value of a bond will vary over time and even over the course of a single day. Factors that influence bond prices include market conditions as well as general supply and demand.

Because bond prices change, it’s possible for a bond to be worth more or less than its face value. It’s also possible to buy a bond for more or less than its par value. (However, you will still receive the par value of the bond once it reaches maturity.) These changes in price drive investors to consider the duration. Duration tells them how a bond’s price could fluctuate, either up or down, in the future. Knowing how prices could change over time allows you to attempt to make money from the purchase and sale of bonds.

## How Bond Maturity Impacts Duration

Like other fixed-income securities, such as certificates of deposit (CDs), the maturity date of a bond is the date when your bond will reach the end of its term, also known as reaching maturity. For a 10-year bond, the maturity date is 10 years after the date of issue. When a bond reaches maturity, you will receive the par value of the bond. A bond’s maturity is set when it’s issued and will not change during the bond’s term.

Similarly, the term to maturity is how long you have between now and your maturity date. The term to maturity will get shorter as your bond’s maturity date draws closer. Duration (specifically Macauley duration) and term to maturity move in the same direction. As the term to maturity decreases, so does duration. That’s because as maturity approaches, there is less time between now and when you will receive the entirety of future payments from the bond. Thus your risk of losing value in the future is lower.

## How Coupon Rate Impacts Duration

Coupon rate is the interest yield of a bond. This is an annual rate. So if you have a \$1,000 bond with a 5% coupon, you will earn \$50 of interest from the bond each year (5% of \$1,000). A bond will pay this amount in addition to its par value.

It’s worth mentioning coupon rate just to say that it shouldn’t be confused with the interest rates that determine bond prices. The rates that impact prices are the market interest rates. A bond’s coupon rate is set in its initial terms.

## How Duration Impacts Your Portfolio

When deciding what asset allocation to use for your portfolio, it’s important to consider how much risk you take on from your investments. Everyone’s risk tolerance is different and even though bonds often pose a lower risk than other securities, there is still a risk when investing with bonds. The duration of a bond helps you determine that risk.

## The Bottom Line

The duration of a bond tells you how sensitive that bond’s price is to changes in interest rates. Duration is represented in years and a higher duration means the bond has a higher sensitivity to interest rate changes. Duration is important because it helps you assess the risk that you’re adding to your investment portfolio if you buy a certain bond. More generally, it also helps you determine whether or not a bond or bond fund is a good fit for your investing plan.