Average Life

A human: 85 years. A Galapagos turtle: 400+. A bond portfolio? All over the map.

So you're buying into a mutual fund carrying bonds only rated BBB. Because they're somewhat risky, they carry an interest rate premium, which makes you happy. But you're worried about inflation taking off in three or four years, so you care a lot about the average life of the bonds in the portfolio. If the average life was two and a half years, and most of the bonds came due in four years or less, then you could probably sleep like a baby every night.

But if the average life is more like 15, 16, 20 or 30 years, then if inflation hits in just four years, those bonds will go down a ton.

The other name for average life is "weighted average maturity," or "weighted average life." So what is being weighed here? Answer: the dollar amount of the principal of the bond. That is, you could have a portfolio with just three bonds. One is a billion dollars, another is ten million, and another is two million. Well, the vast majority of this portfolio's value will be driven by that billion-dollar bond. It carries an extremely high weighting in this average life calculation.