Why bond ETFs fall when rates rise — reading duration
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Bonds are supposed to return your principal. So why did a bond ETF drop twenty percent? Because it never holds to maturity.
Prices and rates move opposite
Say you hold a bond paying 3% and market rates rise to 5%. Newly issued bonds now pay 5%, so nobody wants yours at face value.
It only sells at a discount. Rates up, existing bond prices down — and the reverse when rates fall.
A bond ETF reflects those price moves directly. Hold a bond to maturity and you get your principal back, but the fund keeps trading to maintain its maturity profile, so that day never arrives.
Duration: how much a 1% move hurts
Duration estimates the percentage price change for a one-point move in rates. Duration of 8 means roughly an 8% fall if rates rise a point.
Longer maturities carry higher duration — a 30-year treasury fund can exceed 15, implying close to a 30% drop on a two-point rise.
This is where "bonds are safe" breaks down. Safety refers to the issuer repaying you; price volatility is a separate matter entirely.
Maturity changes the product
Short-dated funds (duration 1-3) barely react to rates — closer to a parking place for cash.
Intermediate (3-7) is the balance point, mixing income with moderate price movement, and does the work in most allocations.
Long (10+) is effectively a bet on the direction of rates: large gains if they fall, large losses if they rise. Not something to hold for stability.
What to check
Duration first — that single number nearly defines the product. "Long" or "30-year" in the name means expect movement.
Then credit quality. Government and corporate are not the same thing, and a fund paying a notably higher yield is carrying default risk to do it.
For foreign bonds, check the currency hedge. Unhedged, exchange rates can dominate whatever the bonds earn.
This article is general information, not investment advice. Investment decisions and responsibility are your own.