Bonds
When interest rates move, check duration
Two debt portfolios can respond very differently to the same change in yields.
One rate move, different outcomes
When I worked in treasury, a change in rates was a reason to review the portfolio’s sensitivity and where maturing money would go next. The same discipline is useful for personal portfolios.
A debt investment is not insulated from market prices simply because it is described as fixed income. Two portfolios with similar quoted yields can behave differently when market yields change.
Duration is a measure of sensitivity
Modified duration estimates how sensitive a bond’s price is to a small change in yield. As a rough first-order calculation, percentage price change is the negative of modified duration multiplied by the yield change in decimal form.
For illustration, modified duration of four and a yield rise of half a percentage point imply an approximate price fall of 2%. This is an estimate, not a forecast: convexity, spread changes and other factors affect the actual outcome.
Separate existing investments from new money
A rise in yields can put pressure on existing fixed-rate bond prices. At the same time, new investments may be available at different yields. Those are two sides of the same change, not a contradiction.
A higher starting yield does not, by itself, make a new bond suitable. Credit risk, tenure, price and the possibility of needing an early exit still need attention.
The maturity date is not the whole answer
Check the duration reported for a debt fund and understand the strategy behind it. A fund’s portfolio can change, so a snapshot is not a promise that its sensitivity will remain constant.
For an individual bond, consider payment timing, any call option and what would happen if you needed to sell. Holding to maturity does not remove the issuer’s obligation risk, and coupons may have to be reinvested at rates you did not expect.
Three useful review questions
How sensitive is this investment to a change in yields? When do I actually need the money? What assumptions am I making about repayment and reinvestment?
You do not need to predict the next central-bank decision to ask those questions. Their purpose is to understand how a change in rates could affect your plan before the market makes the answer uncomfortable.