The Difference Between Duration and Maturity

Many people mistake 'maturity' and 'duration' for the same thing. But they're different.

Maturity is simple. It's the time until you finally get your principal back. For a '10-year bond,' you receive your principal 10 years later.

Duration is a slightly more refined concept. Considering all the cash flows from a bond—the interest received along the way and the final principal—it's the time-weighted average of 'roughly when, on average, you recover your investment.' So duration is always shorter than or equal to maturity.

The secret lies in 'the interest you receive along the way.'

An interest-paying bond delivers cash in between, so you don't have to wait until maturity. Because the times you receive that interest pull the recovery point earlier, the average recovery period (duration) becomes shorter than maturity.

Conversely, a bond like a zero-coupon bond that delivers cash only once, at maturity, has just one recovery point—maturity. So only in this case does duration exactly equal maturity.

To sum up, even for the same maturity, the more interest a bond pays, the shorter its duration; the less interest, the longer its duration.

The real reason duration matters is that it tells you 'rate sensitivity.'

There's a simple approximation. When rates change, a bond's price change is roughly 'duration × the rate change.' The direction is opposite (when rates rise, the price falls).

For example, a bond with a modified duration of 7 falls about 7% when rates rise 1% (100bp) and rises about 7% when they fall 1%. A bond with a duration of 3 moves only about 3% for the same rate change.

So even with the same maturity, a bond with a larger duration swings more with rates. This is exactly why, in the earlier example, only one of the same-maturity bonds fell sharply.

Knowing duration lets you roughly gauge how much your bond (or bond fund) will swing with rate changes.

If you're worried rates might rise, a bond with a short duration swings relatively less. Conversely, if you expect a big gain from falling rates, a bond with a long duration reacts more. Bond funds also disclose an 'average duration,' so you can estimate rate sensitivity from that number.

That said, this approximation fits well for small rate changes, and an error (the convexity effect) appears when rates move a lot. It's safer to use it as a tool for grasping 'a rough sense of sensitivity' rather than 'an exact prediction.'