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Online Investing Hacks by Bonnie Biafore

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Hack #64. Manage Interest Rate Risk with Bond Fund Duration

Use bond fund duration to find out whether your bond fund investments could tank if interest rates rise.

When you buy a bond, you receive ongoing interest rate payments based on the interest rate set when the bond was issued. That rate might be great or lousy compared to current market interest rates, but at least it’s guaranteed as long as you hold onto the bond. Bond prices are another story. They move in the opposite direction of interest rates, rising when interest rates fall, falling when interest rates rise. Bond investors made out like bandits in the 1990s when they sold their bonds after interest rates fell for several years in a row. However, bond funds don’t work like bonds. Bond managers don’t hold onto bonds, so you don’t get a guaranteed return as you do if you hold a bond until it matures. Bond fund values and the returns you receive change along with interest rates. You can find out how much you stand to lose or gain from interest rate changes by checking the duration of your bond fund—and switch to a lower risk investment if the potential drop is too big.

Bonds Versus Bond Funds

Bond funds are made up of bonds [Hack #2] and [Hack #80] ], but they’re riskier and you could get into big trouble if you don’t understand the risks. Bonds are debt issued by governments and corporations, who promise to pay ongoing interest to bondholders and then return the bondholders’ original investments when the bonds mature. ...

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