For more than 25 years, declining interest rates have driven prices in the bond markets higher, leading to strong returns for investors. But with interest rates today near their all-time lows, investors can't count on further declines to drive future returns.

What happens when interest rates rise?

Bond prices and interest rates generally move in opposite directions — when rates rise, the value of existing bonds decline. The degree of a bond's sensitivity to those interest-rate changes is measured by duration.

Because today’s low rates offer so little income to offset any price declines, even a small increase in rates could lead to significant losses for certain types of fixed-income securities.

Effective federal funds rate, 10-year Treasury yield

What happens when interest rates rise? Show rising rates

Sources: U.S. Department of the Treasury, Federal Reserve, as of 6/30/13.

Why duration matters

For every 1% change in interest rates, a bond's price is expected to move 1% in the opposite direction per year of duration. In other words, the higher a bond's duration, the more sensitive it is to interest-rate movements. For investors who own individual bonds and are willing to hold them until maturity, duration may not be much of a concern. But investors in a government- or index-oriented portfolio who need even a small degree of liquidity should pay careful attention to the level of interest-rate risk they're assuming.

Sources: U.S. Department of the Treasury, Barclays, Putnam Research, as of 6/30/13. 
The Barclays U.S. Aggregate Bond Index is an unmanaged index of U.S. investment-grade fixed-income securities. You cannot invest directly in an index. For illustrative purposes only. Performance of Putnam funds will differ.