Stocks & Bonds

2 Key Numbers to Understanding Bond Funds

Get to know your bond funds by learning about these important data points.

By Bob Frick, Senior Editor

From Kiplinger's Personal Finance magazine, September 2010

Yes, yields could fall further. That would be a boon for investors because bond prices move inversely with interest rates. But let's get real: Rates can't fall below 0%, and they could theoretically rise to the moon.

All the more reason that investors must know about duration, which measures a bond's sensitivity to interest-rate moves. The higher the duration, which is measured in years, the more a bond's price will change with moves in interest rates. For example, a duration of 5 means that for every percentage-point rise in rates, a bond will lose roughly 5% of its value (and gain 5% for every percentage-point decline in rates).

Generally, the longer a bond's term, the longer its duration and the greater its yield. So the average duration of funds that invest in short-term bonds is shorter than the average duration of funds that own long-term bonds. Nowadays, the prudent course is to focus on funds with short durations (less than 6), even if it means accepting low yields. You can usually find duration at a fund's Web site.

Another important number is the 30-day yield, or SEC yield (SEC stands for the Securities and Exchange Commission). This is a standardized number meant to help investors compare income rates among different bond funds by looking at the yield to maturity of a fund's holdings. YTM recognizes that bonds that currently sell for more or less than face value will pay off at face value when they mature. The SEC yield differs from a fund's distribution rate, which takes a year's worth of payouts and divides by the current share price. Distribution yields are typically better than SEC yields at indicating what a fund is paying currently, but SEC yields do a better job of forecasting what a fund will pay out in the coming year or so.

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