Why bond prices fall when interest rates rise

A bond is a loan you make. You hand a government or a company your money, they promise to pay you a fixed amount of interest every year, and they return the original sum on a set date. That fixed interest payment is called the coupon, and it never changes for the life of the bond. The coupon is locked. Interest rates out in the world are not. When new bonds start paying more than yours, buyers stop wanting yours at full price, so its price drops. When new bonds pay less, yours looks generous and its price climbs. That seesaw between bond prices and interest rates is the one idea that explains almost everything bonds do.

Why a fixed coupon makes the price move

Say you buy a $1,000 bond that pays a 3% coupon. Every year it sends you $30, and at maturity you get your $1,000 back. Nothing about that deal changes once you own it. The $30 is fixed.

Now interest rates rise. New $1,000 bonds of the same quality start paying 5%, which is $50 a year. Your bond still pays $30. Anyone choosing between the two will take the $50 bond, so nobody wants to buy yours for the $1,000 you paid. To sell it, you have to drop the price until the $30 it pays works out to a competitive yield near 5% for the new buyer. The coupon cannot rise to meet the market, so the price falls instead. That is the whole mechanism.

The worked example

Hold your 3% bond next to the math and watch what the price has to do. Your bond pays $30 a year. A buyer today can get 5% somewhere else, so they will only accept your bond if its $30 payment represents roughly a 5% return on what they pay for it. Flip the arithmetic: $30 divided by 0.05 is $600. A buyer paying about $600 for a bond that pays $30 a year earns the 5% the market now demands.

Read across the rows and the seesaw is right there. Rates went up, your bond's price went down to about $600. Rates went down to 2%, and that same $30 coupon suddenly looks rich, so a buyer pays $1,500 to get it. Your coupon never moved. Only the price did, and it moved in the opposite direction from rates every time.

Duration: how hard your bond reacts

Two bonds can both pay 3% and still react very differently when rates move. The thing that separates them is duration. Duration measures how sensitive a bond's price is to a change in interest rates, expressed in years. The rough rule: for every 1 percentage point that rates move, a bond's price moves by about its duration, in the opposite direction.

A bond with a duration of 3 loses roughly 3% of its price when rates rise 1 point. A bond with a duration of 15 loses roughly 15% on the same move. Same 1-point shift, five times the damage. Longer-dated bonds carry longer durations, which is why a 30-year Treasury whipsaws while a 2-year barely flinches. In 2022, when the Federal Reserve raised rates fast, long-term Treasury funds fell more than 30% in a single year, the kind of loss most people file under stocks. That was duration doing exactly what it does.

• Short duration (1 to 3 years). Small price swings, lower yield, your money comes back sooner.
• Long duration (10 to 30 years). Bigger price swings, usually higher yield, more exposed to every rate move.

You can see why duration matters before you ever buy. Pick a bond fund with a duration that matches how long you can leave the money alone. If you might need the cash in two years, a long-duration fund can hand you a loss at the worst time. The investing guide walks through how this fits a full portfolio.

Why hold something this dull

Bonds are not where you go for growth. Stocks have returned around 7% a year after inflation over the long run; high-quality bonds return far less. You hold bonds to steady the ship. When stocks drop 30% in a recession, the safe bonds in your portfolio tend to hold their value or rise, because nervous money runs toward them and central banks often cut rates, which lifts bond prices. That cushion is the job.

Picture a portfolio that is 80% stocks and 20% bonds during a year stocks fall 25%. The stock side loses 20 points of your total. If the bond side holds flat or gains a few points, your whole portfolio is down something like 19% or 20% instead of 25%. A smaller hole is easier to climb out of, and easier to sit through without panic-selling at the bottom. That is worth more than it looks on a calm day. Run your own mix through our compound interest calculator to see how a steadier path compounds over decades.

How much you hold depends mostly on your age and timeline. A 25-year-old with forty years ahead can hold very little in bonds, because they have time to ride out stock crashes. Someone five years from a goal holds far more, because they cannot afford a 30% stock drop right before they need the money. That shifting mix is the glide path covered in our piece on how your investment mix should change with age.

The short version

A bond pays a fixed coupon. New bonds set the going rate. When the going rate rises above your coupon, your bond is worth less, so its price falls until its yield catches up; when the going rate falls below your coupon, your bond is worth more and its price rises. Duration tells you how hard that price will swing. And the reason you own any of it is to lose less on the days stocks lose a lot.

FAQ

Why hold bonds at all when stocks return more?

Because returns are only half the story; the path matters too. Stocks pay more over decades, but they can fall 30% or 40% in a single bad year, and if that year lands right before you need the money, the higher long-run return does you no good. Bonds smooth the ride. In most stock crashes, high-quality bonds hold steady or gain, which keeps your total loss smaller and keeps you from selling in a panic at the bottom. The younger you are, the fewer bonds you need, because time lets you wait out stock drops. As your goal gets closer, bonds earn their place.

What is duration?

Duration measures how sensitive a bond's price is to interest rate changes, measured in years. As a rule of thumb, a 1 percentage point rise in rates pushes a bond's price down by roughly its duration. A duration of 4 means about a 4% price drop on a 1-point rate rise; a duration of 12 means about 12%. Longer-dated bonds have longer durations and swing harder. Match your fund's duration to how long you can leave the money untouched, and a rate spike is far less likely to catch you out.

Are bonds actually safe?

Safer than stocks, not risk-free. A U.S. Treasury bond will pay you back; the government has never defaulted, so there is almost no chance you lose your principal if you hold to maturity. But the price along the way still moves with interest rates, and a long-duration bond fund can post a double-digit loss in a year rates jump, as long Treasuries did in 2022. Corporate bonds add a second risk: the company can run into trouble and miss payments. Lower-rated "junk" bonds pay more precisely because that risk is real. Stick to short and intermediate high-quality bonds and you get most of the stability with far less of the drama.

Should I buy individual bonds or a bond fund?

For most people, a low-cost bond fund. A single bond ties up a chunk of money in one issuer and one maturity date, and buying a spread of them takes real money and effort. A bond fund holds hundreds of bonds across different maturities for a few dollars a year, spreads the risk, and reinvests as bonds mature. The catch is that a fund has no single maturity date, so its price keeps floating with rates rather than snapping back to face value on a known day. For a long-term investor building a steady portfolio, that trade is an easy one to make.