Boring Topics
How do you make a really boring topic interesting?
You make it relevant.
Think about it, in these last handful of years, we have all been captivated by historically boring topics like viruses, inflation, and tariffs. Traditionally, not the most popular dinner table conversations, yet relevant and therefore interesting.
Today I want to talk to you about bonds, and specifically duration. The challenge in front of me is to prove to you that duration is a relevant topic and one that should interest you.
So here I go…
Understanding Stocks & Bonds
A stock is when you have ownership in a company. Imagine you own a lemonade stand in our neighborhood and you need some cash to buy more lemons and sugar. You ask me for some money in exchange for the opportunity to share in your profits, this is a stock. I would own stock in your lemonade stand. Now imagine you didn’t want to share those future profits, but you still needed the money. Maybe you would ask me for a loan with the promise to pay me back with interest; this is a bond. I would own a bond issued by your lemonade stand.
Bonds can come in all different shapes and sizes. The money can be borrowed for a short time (a few months) or a long time (30 years). The interest rate could be fixed, or it could be adjustable throughout the term of the loan, along with many other nuances and variations.
Understanding Duration
Now, back to our lemonade stand. Let’s say that you borrowed $1,000 from me and you said you would pay me interest over a 5-year period, then return my original $1,000. You’ve agreed to pay me 4%, we landed at this rate based on the average rate other lemonade stands were paying at the time. Then, one year later, two things happen: (1) the lemonade stand needs to borrow more money, and (2) I (the lender) am also in need of some money. Luckily, your friend Mike is interested in lending new money to the lemonade stand as well as taking over (buying) my existing bond. Things have changed over the last year, though. The other local lemonade stands are now paying 5% interest on the bonds they are issuing, so Mike expects to get paid 5% as well. This poses a problem because my bond was issued at 4%, which makes my bond less financially attractive than the new loan (bond). Mike will provide the lemonade stand. So, how is this problem solved? We know that I am set to get paid back $1,000 in 4 years, so I will need to give Mike a discount of $1,000 to take over (buy) this loan (bond) from me. The discount will make up for the lost interest Mike will have based on the difference in rates between my bond and the new bond over the next 4 years.
That was a mouthful of a story, but the good news is that you now know what duration is. Duration describes the sensitivity of a bond price based on changes in interest rates. So, if a bond portfolio had a duration of 7, this would mean that a 1% change in interest rates would equate to a 7% change in the price (or value) of the bond. There is an inverse relationship between rates and bond prices. Use our story from above as an example, when rates went up, the resale value (price) of my bond went down – my bond was less attractive in that rate environment, so I had to apply a discount to the price. If the opposite happened, rates went down, then I could sell my bond at a premium as my bond would be more attractive than new bonds being issued in the marketplace.
Urgency in 2020, Patience in 2025
So, why does this all matter? Well, the bond market is a $140 trillion market, larger than the stock market, and many of the folks reading this article – including the guy writing it – own bonds. Additionally, we now understand that changes in rates could have a positive or negative impact on the value of our bonds.
Next, let’s take a stroll down memory lane. In the height of the COVID-19 pandemic, in early March of 2020, the 10-year government bond interest rate fell below 0.50%. This was the all-time record low. So, what should an advisor’s advice be when rates get this low? Let’s think through this one logical step at a time. First, if rates go up from that all-time low, which felt likely, then bond prices would suffer – again, an inverse relationship between prices and rates. If rates stayed the same for an extended period, which could technically happen, then the investor is getting paid somewhere in the range of 0.50% for taking this risk. Is that compensation worth that risk now, knowing how duration works? The answer is no. The only other potential direction would be rates going down or even negative – I felt this to be improbable, although possible, but still the risk/reward skew was not in favor of the investor. So, the right advice in that moment was to taper down or, in some cases, eliminate that bond allocation – cash became an appropriate and more stable surrogate in that moment.
The total return (cumulative) of the aggregate bond index from March of 2020 to the end of May 2025 has been roughly -3%. For perspective, median home prices have gone up by a third over that same time period, which simply helps show the eroded buying power of that bond portfolio.
So, in Q2 of 2020, I was expressing a high level of urgency to my clients that we needed to re-size those bond allocations because of what I explained above. What about today? Am I expressing the same urgency for an investor that might be, in my opinion, heavy-handed in their bond allocations? I am not. To me, duration makes all the difference here. What seemed to pose an obvious headwind when rates were at an all-time low could now become a tailwind for investors as rates are close to a two-decade high.
Conceptually, I do believe an investor’s portfolio should have a bias towards risk assets (stocks, real estate, higher-yielding bonds, etc.) as these assets are traditionally the best weapons to combat inflation and help an investor retain and grow their buying power. I look at cash and high-quality bonds to create the appropriate safety nets in case of emergency or to allow another resource to draw from in times of calamity – more of the medics than the infantry when it comes to that war on inflation.
So, my advice in 2025 and 2020 are the same/similar in where I believe your asset allocation should land, but how you implement that change does differ. In 2020, I expressed an urgency to make that change swiftly, while in 2025, I would advise a longer staged transition. I would be advising new clients that have a long-held portfolio biased towards fixed income (bonds) to be dollar cost averaging out of that approach and into what I would describe as the more ideal and long-term fit portfolio.
Bring it All Together
Is that blanket advice to be applied in all situations? Of course not. If you’ve read Thoughts On Money for some time, you should know there is always nuance, and each situation should be addressed individually. The primary takeaway I want you to gather here is (1) what duration is, (2) how duration can hurt or help you, and (3) where rates currently sit can drive the speed with which you make allocation changes.
Did I make the topic of duration interesting? I will let you be the judge of that. I will say this, I have lots of conversations about my Expense Based Planning (EBP) method for asset allocation and I simply want to reiterate that transitioning from what you are doing today to what I think makes the most sense via the EBP method will look different based on (1) how you are currently allocated and (2) where rates are. Duration is very relevant in that sense. In 2020, it was like you were late for a flight, you just needed to run through the terminal – a time of urgency. In 2025, you showed up early to the airport and you’ve got plenty of time to grab a bite to eat and window shop before heading to your gate – a time of patience.
As always, keep sending your questions our way, and we will continue to craft these articles to best educate and serve our readers. Until next time, friends…
