Monthly Archives: February 2013

Investor Alert- "Duration": What an Interest Rate Hike Could Do to Your Bond Portfolio

Duration—What an Interest Rate Hike Could Do to Your Bond Portfolio
The following article is from the FINRA Investor Education Foundation newsletter

If you own bonds or have money in a bond fund, there is a number you should know. It is called duration. Although stated in years, duration is not simply a measure of time. Instead, duration signals how much the price of your bond investment is likely to fluctuate when there is an up or down movement in interest rates. The higher the duration number, the more sensitive your bond investment will be to changes in interest rates.


Currently, interest rates are hovering near historic lows. Many economists believe that interest rates are not likely to get much lower and will eventually rise. If that is true, then outstanding bonds, particularly those with a low interest rate and high duration may experience significant price drops as interest rates rise along the way. If you have money in a bond fund that holds primarily long-term bonds, expect the value of that fund to decline, perhaps significantly, when interest rates rise.

 How Duration Risk Affects Price

 Many factors impact bond prices, one of which is interest rates. A maxim of bond investing is that when interest rates rise, bond prices fall, and vice versa. This is known as interest rate risk. But just as some people’s skin is more sensitive to sun than others, some bonds are more sensitive to interest rate changes than others. Duration risk is the name economists give to the risk associated with the sensitivity of a bond’s price to a one percent change in interest rates.

The higher a bond’s duration, the greater its sensitivity to interest rates changes. This means fluctuations in price, whether positive or negative, will be more pronounced. If you hold a bond to maturity, you can expect to receive the par (or face) value of the bond when your principal is repaid, unless the company goes bankrupt or otherwise fails to pay. If you sell before maturity, the price you receive will be affected by the prevailing interest rates and duration. For instance, if interest rates were to rise by two percent from today’s low levels, a medium investment grade corporate bond (BBB, Baa rated or similar) with a duration of 8.4 (10-year maturity, 3.5 percent coupon) could lose 15 percent of its market value. A similar investment grade bond with a duration of 14.5 (30-year maturity, 4.5 percent coupon) might experience a loss in value of 26 percent.1 The higher level of loss for the longer-term bond happens because its duration number is higher, making it react more dramatically to interest rate changes.

Duration has the same effect on bond funds. For example, a bond fund with 10-year duration will decrease in value by 10 percent if interest rates rise one percent. On the other hand, the bond fund will increase in value by 10 percent if interest rates fall one percent. If a fund’s duration is two years, then a one percent rise in interest rates will result in a two percent decline in the bond fund’s value. A two percent increase in the bond’s fund value would follow if interest rates fall by one percent.

Variables such as how much interest a bond pays during its lifespan as well as the bond’s call features and yield, which may be affected by changes in credit quality, play a role in the duration computation. Maturity—the length of time before the bond’s principal is repaid—also plays a role.

Math aside, once you know a bond’s or bond fund’s duration, you can predict how it will react to a change in interest rates.

Duration Details

To find your bond fund’s duration, look for it in the fund’s Fact Sheet, often in the Bond Holding Statistics section. Finding the duration of an individual bond can be a bit trickier. Start by asking your investment professional or the bond’s issuer. There are also online calculators available that compute an individual bond’s duration.

In some cases, more than one duration number is computed. For example, Macaulay Duration calculates a bond’s basic duration, while Modified Duration is a modified Macaulay computation that directly measures price sensitivity. Effective duration, on the other hand, is often the calculation cited for bonds with features that change when interest rates change, such as redemption features.

Also, duration for floating rate securities is different and generally shorter than fixed-rate securities of equal maturity, due to the periodic interest rate resets.

Finally, duration assumes that for every movement in interest rates, there is an equal change in bond price in the opposite direction. However, this isn’t always the case. For example, when interest rates drop, a residential mortgage-backed security (a bond backed by home loans) might not see an equal increase in the bond’s price, because it might prompt homeowners to refinance their loans. This in turn may limit increases in the bond’s price as it loses interest paying loans being paid off. Investment professionals use the term “convexity” to describe this relationship.

Low Duration Does Not Mean Low Risk

Just because a bond or bond fund’s duration is low, it does not mean your investment is risk-free. In addition to duration risk, bonds and bond funds are subject to inflation risk, call risk, default risk and other risk factors. These factors will be discussed in a bond’s offering document or a bond fund’s prospectus. For a more complete discussion of bond risk factors, visit FINRA’s Smart Bond Investing.

Additional Resources

 1 Fitch Ratings, Macro Credit Research Report, The Bond “Bubble”: Risks and Mitigants, 2012
 Visit FINRA Investor Education.

If you have any questions about this and want to learn further from Your Trusted Financial Advisor, we’d be happy to have that discussion with you.

Check your Beneficiaries

OK here is your call to action- Check the beneficiaries designations on your assets- this weekend. Think of it as a Valentine day gift to your loved ones.
The cost/benefit ratio of this exercise is excellent and if you get it right your wishes are followed. If you fail to act and the designations are wrong… it will be too late to fix them after you die.

I begin each day by reading Investors Business Daily and on 2/11/13 IBD had an excellent article called “Time to Check Beneficiaries” pasted in below.

Time To Check Beneficiaries

Avoid Costly Probate As family events occur, 401(k)s, IRAs, insurance policies need updating

If you’re finally getting around to writing that will or just doing the periodic review, don’t forget to check your named beneficiaries on other documents. If you don’t, your assets might not wind up where you want after your death. That’s because some assets go to beneficiaries you’ve named in individual account documents. Those trump whatever is in your will.

A worker named John Hunter participated in his employer’s retirement plan. He named his wife as beneficiary, but no backup. After she died, Hunter did not name a replacement beneficiary. Then Hunter died without anyone designated to inherit his account. Hunter’s company plan had a formal procedure for deciding who will inherit in such cases. A surviving spouse would be first choice.
Then would come surviving children, parents and siblings, in that order. Hunter had no surviving children or parents, so the plan administrator divided Hunter’s account, worth over $300,000, among Hunters’ siblings. But Hunter had two stepchildren from his marriage. He left his estate to them in his will. So the stepsons sued to get Hunter’s retirement account. They won one court victory but lost on appeal. The appellate court held that the plan administrator acted properly. Plan documents did not say that stepchildren were beneficiaries, and they could be excluded. “This shows the importance of beneficiary designation forms,” said Beverly DeVeny, a consultant with retirement expert Ed Slott.

The Right People
To be confident that your retirement money will go to the right people, you should name a secondary as well as a primary beneficiary and review the form periodically. The ruling on Hunter’s plan echoed a unanimous Supreme Court decision. A corporate employee had been divorced, and his wife waived her interest in his company retirement plan as part of the settlement. But the divorced employee never changed the plan’s beneficiary designation. He died years after the divorce and the plan paid out the money to his ex-wife, who was still named on the form. The employee’s estate sued and lost in the Supreme Court. “The documents control,” the Court noted. And that’s the message you should keep in mind.
The types of accounts and plans steered by this rule include life insurance policies because death benefits go to named beneficiaries. The same is true for annuities, IRAs and other retirement plans.
Some bank and investment accounts are payable-on-death or transfer-on-death. Their balances go to the named beneficiary. Be sure they reflect your current wishes.

Avoiding Probate
When accounts or insurance proceeds pass to a designated beneficiary, probate isn’t involved, which can save your estate or heirs time and legal costs. Insurance policies and accounts with beneficiary designations often hold sizable amounts. Leaving these assets outright to a loved one might not be a wise choice. Things to consider before you do include whether the beneficiary is a spendthrift, who’ll fly through an inheritance. Or that person might not be able to make savvy financial decisions.
If you have such concerns, consider naming a trust as the account or policy beneficiary. A trustee can protect your loved one, the beneficiary, as well as provide cash flow. For retirement accounts, some trusts can stretch out required minimum distributions over an individual’s life expectancy.

Should you have any questions or wish to discuss this further with a Trusted Financial Advisor, please feel free to give us a call and we’d be happy to have that conversation.

Likewise consider getting the new year off to the right start with an ICE Book.

Simple Ways to Guard Against Data Thieves

Every moment of the day, both internal and external digital attacks can be made against you or your firm. How can you best guard your assets? Data thieves are more active than ever, trying to access and steal vital information.

According to a recent study conducted by Symantec, mobile security threats, otherwise known as cybercrime, cost consumers $110 billion worldwide in 2011 and $21 billion in the United States alone.*

Our strategic business partner SEI Investments is pleased to offer you a timely video and a checklist of what to do and not do in terms of protecting your data and sensitive client information.

Watch SEI’s latest video for important tips and download the checklist with do’s and don’ts about protecting your data.
 *PC World,  September 2012

Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company.1 Freedom Valley Drive, P.O. Box 1100, Oaks, PA 19456