Bond Duration

Bond Duration is a measure of a bond's sensitivity to interest rate changes. Specifically, it represents the approximate percentage change in a bond's price for a 1% change in interest rates. A bond with a duration of 10 years will lose approximately 10% in value if interest rates rise by 1%.

There are two main types of duration: Macaulay Duration (the weighted average time to receive cash flows) and Modified Duration (the price sensitivity measure). For practical portfolio management, Modified Duration is the more useful figure.

Duration is critically important for risk parity portfolios like All Weather and Permanent Portfolio, which hold significant allocations to long-term government bonds. When interest rates are low and expected to rise (as in 2022), long-duration bonds face severe price risk. The Permanent Portfolio's 25% allocation to long-term bonds lost over 30% in 2022 alone.

Short-duration bonds (1–3 years) have minimal interest rate risk but lower yields. Long-duration bonds (20+ years) are more volatile but provide powerful diversification during deflationary periods or stock market crashes, when investors flee to safety and drive bond prices up.