The bond ladder concept can be simple at the outset: You just need some basic arithmetic to divide up your fixed income allocation into a staggered schedule designed to mature at predictable intervals. Dependable cash flow can provide peace of mind, and spreading maturities can spare you from making big bets on interest rate directions.
Easier Than Cleaning Gutters
Begin by deciding how much money to invest and how many years you want to spread it over. After you purchase the bonds, you can sit tight, receiving their regular interest payments until they mature. At that juncture, you could reinvest the principal at the front of the ladder or use it for something entirely different. Meanwhile, interest rates may have risen, allowing you to reenter the market at a higher rate, receiving a higher yield.
The system is highly flexible. It serves for all varieties of bonds, from Treasuries, Treasury inflation-protected securities, and municipal bonds to corporate issues and high-yield junk bonds, which all follow the same principles: They pay out a set level of cash flows to investors over time and repay the principal amount invested at maturity. You can also make a ladder with certificates of deposit, which are a type of savings account that pays interest on money deposited for a specific period. In short, you can ladder almost anything that offers a fixed payment.
When you construct your ladder, you must pay careful attention to the credit quality of the instruments, interest rates, and maturity dates. Remember that higher-rated bonds tend to provide a more reliable income stream and a more predictable final value at maturity time. Think of it as an ongoing process, like a moving assembly line belt. The bonds are constantly coming due and being reinvested at the prevailing interest rate as they mature.
Could Walking Under a Ladder be Lucky?
The ancient Egyptians started all those ladder superstitions. They placed a ladder inside their tombs so the dead could ascend, and believed the area between the wall and ladder should be avoided so as to not disturb the spirits.
Bond investors, by contrast, can adopt ladders to enhance their fortunes. They can utilize them for diversification, to mitigate the impact of any single rate change on their portfolios, smoothing out fluctuations. The more rungs — or separate maturities — in a ladder, the more diversified it will be. As another important benefit, retirees and pre-retirees appreciate the predictability of income streams they can arrange for monthly payments.
Consider this scenario: If interest rates do decline, some part of your portfolio will still be supported at the higher yields locked in earlier. On the other hand, if rates are rising, you could be sitting on cash you have freed up through maturities, and which can now be redeployed more profitably. This flexibility empowers you to adapt to changing market conditions.
You will still face challenges. You cannot entirely eliminate default risk for nongovernment bonds. What you can do is undertake complex research to choose appropriate bonds and monitor them. Even so, you will obtain less diversification than with a bond fund.
Trading costs and minimum investment requirements may be another hurdle. Since bonds typically trade in denominations of $1,000, it takes sufficient capital to construct a realistic ladder. Otherwise, a Treasury or CD ladder might work better with smaller sums.
Target Maturity Bond ETFs
These funds are a more recent development that can help beat the cost of assembling expensive individual bonds. While they perform like typical ETFs, a group of bonds matures together in the same year. Annual expense ratios are generally low, and it is some comfort that experts at issuer companies keep an eye on holdings’ creditworthiness and maturities.
Talk With the DWC Wealth Advisors’ Team
Reach out to our DWC Wealth Advisors’ team to talk with one of our licensed financial advisors to discuss whether a bond ladder or other investment types would suit your income needs.
DWC Wealth Advisors provide integrated services to leverage and maximize our clients’ overall financial picture now and for the future. Collaboration between our tax professionals, wealth advisors, and retirement and estate professionals give clients full access to expertise in all things financial to support their lifestyle and legacy goals.
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Investment advisory services offered through Global Retirement Partners, LLC (GRP) dba DWC Wealth Advisors, an SEC registered investment advisor. GRP and Dalby, Wendland & Co., P.C. are separate and unaffiliated entities.
