US News and World Report - How Shorter Duration Can Protect Your Bonds
Matt Hylland was recently interviewed for this article in U.S. News and World Report covering fixed income investing and specifically, choosing an investment based on a bond's duration.
The link to the article is below, but first, a quick explanation - What is a bond's duration?
Duration is a measure of interest rate risk for a bond (or a bond fund). A bond with a higher duration will decline in price much more sharply than a bond with a low duration.
Let's take a look at a couple of popular funds used today for fixed income investing, and see how they have performed since the start of the year in the face of rising interest rates.
First, a bond fund with a duration of 17.2, (which is very high): iShare's 20+ Year Treasury ETF, ticker symbol: TLT. The fund invests exclusively in long term bonds, that is bonds that mature in 20 years or more.
Here is a chart of the prices over the last 5 months from the fund:
As you can see the price of one share of the ETF has fallen from about $126 to $117. The fund is down more than 8% this year - a pretty sharp drop for an investment that many consider to be "very safe".
How does this compare with SPDR's short term treasury bond ETF, ticker: SPTS, a fund with duration of just 1.8?
(Full disclosure: Clients of Hylland Capital Management may own SPTS in their investment portfolios managed by us).
SPTS, which holds bonds with much lower duration, is down just 1.1%, significantly less than the first fund we looked at.
This helps to display the importance of understanding a bond, or bond fund's, duration in your retirement portfolio. Investments that you believe as "safe" or "risk-free" can prove to be quite the opposite! If you are investing money that will be needed in less than a decade, investing in a bond fund such as TLT, with a duration much greater than 10 years, can ultimately be a risky bet, even if the investments are U.S. Treasury bonds.
The article goes on to explain a bit more about how limiting duration in your fixed income investments can help control certain risks, and a few other items to take note of before investing in bonds:
As valuable as duration is, it does not reveal the other big risk bond holder faces – the possibility the issuer will default and fail to pay interest and principal as promised, says Matt Hylland, investment advisor with Hylland Capital Management in North Liberty, Iowa.
"Duration is a way to measure the short-term risks of price fluctuations due to interest rates, but does not measure the risk of the bond issuer [not] paying on the bond," he says.
Shifting to bonds with shorter maturities and duration generally means gaining safety but settling for lower yield.
You can find the entire article here:
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