U.S. securities regulators issued an investor alert Thursday, warning about the possible impact of interest rate hikes on bond holdings.
The Financial Industry Regulatory Authority (FINRA) issued a new alert that aims to help investors understand the importance of duration risk.
For example, it explains that a bond fund with a 10-year duration will decrease in value by 10% if interest rates rise 1%; whereas, if a fund’s duration is two years, then a 1% rise in rates will only lead to a 2% decline in the fund’s value.
“With interest rates hovering near all-time lows, investors should make sure they know their duration numbers. Whether investors own individual bonds or bond funds, they need to understand that outstanding bonds with a low interest rate and high duration may experience significant price drops if interest rates rise,” said Gerri Walsh, FINRA vice president of investor education.
It also advises investors to remember that just because a bond or bond fund’s duration is low, it does not mean the investment is risk free. In addition to duration risks, these instruments face other risks, too, including inflation, call, default and other risks.