A bond ladder is a portfolio of bonds, bond ETFs or CDs that mature at different times. The main goal of a bond ladder is to manage two things: Cash flows and interest rate risk.
Imagine an actual ladder with rungs and everything. To determine how many securities you need in your portfolio, you take the amount you want to invest and then divide it by the number of years that you would like to have the ladder. For example, if you wanted to invest $100,000 over 10 years, you would need 10 securities and your ladder would have 10 rungs.
Most bonds pay interest two times per year. Investors who utilize bond ladders can generate predictable income based on coupon payments with different maturity months and years. This is important for retired individuals, because they often depend on the cash flows from investments as a source of income. Staggering the maturity dates helps smooth out the effects of a change in interest rates since investors are not getting locked into one single interest rate. When a bond matures, the principal would be reinvested in a new long-term bond on the end of the ladder. By staying disciplined and reinvesting the proceeds from the maturing securities, investors are able to deal with interest rate fluctuations.
How Do Bond Ladders Work?
Put another way, if you had $100,000 to invest in Treasury bonds. You could buy 10 different 10-Year Treasury ETF’s with a face value of $10,000. You could buy the following ETFs:
- iShares iBonds Dec 2022 Term Treasury ETF (IBTB)
- iShares iBonds Dec 2023 Term Treasury ETF (IBTD)
- iShares iBonds Dec 2024 Term Treasury ETF (IBTE)
- iShares iBonds Dec 2025 Term Treasury ETF (IBTF)
- iShares iBonds Dec 2026 Term Treasury ETF (IBTG)
- iShares iBonds Dec 2027 Term Treasury ETF (IBTH)
- iShares iBonds Dec 2028 Term Treasury ETF (IBTI)
- iShares iBonds Dec 2029 Term Treasury ETF (IBTJ)
- iShares iBonds Dec 2030 Term Treasury ETF (IBTK)
- iShares iBonds Dec 2031 Term Treasury ETF (IBTL)
When interest rates rise, the investor benefits from higher interest rates as they keep the ladder going. When rates fall, the proceeds from maturing bonds get reinvested at lower rates, but on a positive note, bonds at the end of the ladder would likely already have been invested at higher yields.
Bond Ladder Considerations
Bond ladders can be a good way for retirees to generate a predictable source of income and manage interest rate risk. Other risks that come with investing in bond ladders are liquidity risk and credit quality risk. It’s important to make sure all your eggs are not in one basket. This strategy should be implemented only by individuals who already have enough money set aside in an emergency fund.
If you have any questions or would like to consult with our advisors on the topic of bond ladders, you can schedule a complimentary consultation below.
Bautis Financial Advisor Commentary: February 10, 2022