Duration is a very important concept for bondholders in today’s world of low dividend yields. It measures the degree of risk of principal loss should interest rates rise from our current historically very low levels. For example, a leading investment company offers an exchange-traded fund (ETF) which I believe they correctly state is “representative of the broad, U.S. investment-grade market.” It has an
SEC yield of 1.6% and a duration of 5.0 years. Simply put, if the relevant interest rate rises by 1%, the current market value should drop about 5%. Given a meager 1.6% SEC yield, that is not much reward for
that much risk.
It is no secret that our Federal Reserve is ‘managing’ interest rates in an effort to generate economic growth. Many argue that this policy is unsustainably suppressing interest rates and that the free market or ‘correct’ level of interest rates is much higher.
Predicting and timing moves in interest rates is a “fool’s errand”. The world is full of turmoil. U.S. interest rates could remain low for an extended period. However, government policies often fail and interest rates could spike upward. This would leave many investors with unexpected losses.
One must consider that current dividends may not be sufficient to pay for the potential risks. Caution is recommended.