Do You Know The Difference?
We often talk about maturity when it comes to bonds. When does your bond mature? Well, that word maturity isn't as important as you might think it is. There's another word that's actually even more important. So let's say you have a bond that matures in 10 years. When are you going to get your money back? Well, you're thinking, well, that's a silly question. If I have a bond with a 10-year maturity, I'm going to get my money back in 10 years. Actually, that might not be true. You actually might get your money back in less than 10 years.
Your bond might have a call feature, and that gives the bonds issuer the right to give you your money back sooner than the maturity date. Or you might have a mortgage-backed bond, meaning that your bond is backed by people who got a mortgage. You've actually essentially lent money to homeowners, and people might pay off their mortgage sooner than the 30-year life of the mortgage.
In other words, they might decide to move and sell their house, and if they sell their house, they pay off the mortgage immediately. So you get your money back a lot faster. So the maturity date is not necessarily going to tell you how long you're going to keep your bond. This is why you've got to pay attention to a different word, not maturity, but duration.
Duration is how long you can actually expect your bond to last. Often, duration and maturity are the same. If you have a one-year maturity, your duration is one year, but the two can be very different. So as you're trying to evaluate how long-term is the bond that I'm holding, don't ask about the maturity date. Ask about the duration of the bond. You might be surprised to discover that the duration is less than the maturity date, sometimes a lot less.