Bond duration and maturity: two different measures

A bond fund factsheet may show both an average maturity and a duration figure, each expressed in years. They answer different questions. Maturity concerns when bonds are due to repay. Duration is used to understand sensitivity to changes in yields.

Neither number tells you that a bond fund will return your original investment after that many years.

Begin with the repayment date

For an ordinary individual bond, maturity is the contractual date on which the issuer is due to repay the principal. Receiving the promised amount depends on the issuer meeting its obligations and on the bond's terms.

A fund may hold many bonds with different maturity dates and replace them over time. Its average maturity describes the holdings at a point in time; it is not normally a maturity date for the fund itself.

Before linking a bond fund to a future household bill, establish whether it has a particular target maturity structure or is an ongoing portfolio. The name alone may not settle that question.

Read duration as sensitivity

Vanguard explains the relationship between duration and bond price movements. A longer duration generally means greater price sensitivity to yield changes, other things equal. Coupon payments, maturity and yields affect the measure.

For a simple illustration using modified duration, a duration of six suggests an approximate 6% price fall for a one percentage point increase in the relevant yield. It also suggests an approximate 6% rise for a one percentage point decrease, before other effects.

This is a local estimate, not a promised outcome. Larger moves, changing credit spreads, non-parallel yield changes and other features can make the approximation less accurate.

Compare two fictional holdings

Assume two bond portfolios each start at £20,000. Portfolio A has modified duration two; Portfolio B has modified duration seven.

For an assumed 0.5 percentage point rise in all relevant yields, the simple duration estimate is a 1% fall for A and a 3.5% fall for B. That corresponds to approximately £200 and £700 respectively, excluding income and all other effects.

The comparison illustrates sensitivity. It does not establish which portfolio will perform better or which suits a particular investor. The starting yields, credit quality, costs and investment purpose have deliberately been left out to isolate the duration effect.

Do not substitute a Bank Rate forecast

Bond yields incorporate expectations and can move before an announced interest-rate decision. Different maturities and issuers can also move differently. A change in Bank Rate is not an instruction for every bond yield to change by the same amount.

When an illustration says “yields rise by one percentage point”, ask which yields and what other assumptions are held constant. A scenario is easier to interpret when it identifies the variable being changed rather than using “interest rates” loosely.

This matters when evaluating claims that a fund must rise because rate cuts are expected. An expectation may already be reflected in the price.

Price movement is only part of the result

Bond investment returns can include income as well as price changes. Reinvestment of that income and changes in the portfolio also matter over time. A duration estimate does not calculate a complete holding-period return.

Keep an immediate price-shock illustration separate from a multi-year projection. Combining them without accounting for income or reinvestment can exaggerate or understate the longer-term outcome.

Similarly, do not treat a fund's yield as a guaranteed savings rate. Its value, income and underlying holdings can change, and fees affect the investor's result.

Use duration in the whole financial plan

Ask what the bond allocation is intended to do: provide diversification, support withdrawals, match future liabilities or serve another purpose. Then discuss how much price fluctuation the plan can tolerate before money is needed.

An adviser should explain the duration measure used, the main risks it leaves out and how the proposed fund interacts with the rest of the portfolio. The useful outcome is an understood trade-off, not the assumption that the shortest or longest duration is always preferable.

For context, see investment management and financial planning, cashflow modelling and investment costs.