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Bond Fund/ETF – you gotta know about duration

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May 11, 2012 – Comments (0) | RELATED TICKERS: PTTRX , PRRIX , VWEHX

I was researching a couple of Bill Gross' bond funds, and this along with a Vanguard fund I once owned, I came up with the following:

PTTRX = PIMCO Total Return Fund (max interest rate)

duration = 4.61

PRRIX = PIMCO Real Return Fund (similar, but using inflation adjusted obligations)

duration = 6.36

VWEHX = Vanguard High-Yield Corporate Fund (junk bonds; I sold it because it became a three-bagger and I got nose-bleed)

duration = 4.6

Duration means that for every 1% rise in the 'interest rate', your investment will go down by that %. Yes, you read that correctly. If the Fed Funds rates go up by, say, 2%, your mutual fund will go down by 9.2 % (VWEHX, PTTRX) or 12.7% (PRRIX).

So, if the interest rate is now 4%, it will take you 2 or 3 years of interest income just to make up the fall in fund price, and your net interest income will be negative.

I could go into an explanation about how a rise in interest rates leads to a decrease in the underlying bond price, but I have a headache and this has already been explained elsewhere on TMF.

**this is for bond funds and ETF's only; if you own an actual bond, ignore everything I have said, assuming of course that you hold the bond to maturity and do not try to sell it prematurely on the open market.

 

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