Bonds are loans. Buy one and you receive interest, then your money back at maturity. Bond ETFs bundle hundreds of these together — and behave in a way that surprises investors who expected "safe".

Why bond prices fall when rates rise

This is the mechanism everything else depends on. If you hold a bond paying 2% and new bonds start paying 4%, nobody will buy yours at the old price. Its price falls until its effective yield matches the new 4%. The interest you receive never changed — the market value did.

Hold an individual bond to maturity and you can shrug this off: you still get your face value back. A bond fund has no maturity date; it continuously rolls its holdings. That is why a bond ETF can post a real, lasting loss in a rising-rate year.

Duration: the sensitivity dial

Duration, expressed in years, tells you roughly how much the fund moves for a 1-percentage-point change in rates. A fund with a duration of 7 should fall about 7% if rates rise by 1%, and rise about 7% if they fall by 1%.

This single number lets you match a bond fund to your risk appetite. Short-duration funds barely twitch; long-duration government bond funds can be as volatile as equities.

The two risks you are paid for

  • Interest rate risk — measured by duration. Government bonds have plenty of it and almost no credit risk.
  • Credit risk — the chance the borrower does not pay. Corporate and high-yield bonds pay a higher yield precisely because this risk is real.

High-yield ("junk") bond funds behave uncomfortably like equities in a crisis — they fall exactly when you wanted your bonds to cushion the fall. If bonds are in your portfolio as ballast, that argues for quality over yield.

Which yield number to trust

Ignore "distribution yield", which just tells you recent payments. Look at yield to maturity: the annualised return you would earn if every bond in the fund were held to maturity and nothing defaulted. It is the best available estimate of what the fund will actually deliver from here.

Summary

Pick your duration to match how long you can wait, prefer credit quality if the bonds are there to protect you, and judge the fund by yield to maturity. A bond fund is not a savings account with a better rate — it is a market instrument with its own weather.