Bond Laddering for Rising Rate Environments

Bond Laddering

If you have not been too excited by your bond investment returns in recent years, or in your returns on any of your investments, you might want to consider giving your income a boost through bond laddering. Bond laddering not only can boost return, it can also minimize risk—very wise in this age of market inconsistency.

When you practice bond laddering, you are simply buying a group of bonds with different maturity dates spread out over a given period of time. A 10-year laddered portfolio, for example, would feature bonds that mature in one, two, three, and four years, up to 10 years. To preserve the ladder, you would re-invest in a bond that matures 10 years from now once the first bond matured after year one.

This laddering can increase return on investment because you are not stuck with the minimal returns of a bond that matures quickly. It reduces risk because you have a mixture of short-term and long-term bonds, ensuring some protection from sometimes fickle changes in the interest rate. The end result? A fairly predictable income stream, which most investors would be quite happy with in today’s economic uncertainty, according to Richard Carter, vice president of fixed-income securities in Fidelity’s brokerage division.

Those who opt for bond laddering can end up with the best of both worlds, but not the worst of both in investing. If interest rates are on the rise, the principal from expiring bonds can be reinvested at higher rates. If rates are falling, the long-term bonds will maintain their higher interest gains no matter what the market is currently doing. Thus, a person who chooses bond laddering will almost always end up with a lose-win at worst, and almost never a lose-lose predicament.

Bond ladders enable investors to take advantage of surges in inflation because they have constant cash to roll over into new bonds at the higher rates, thus eliminating the potential downer of fixed payments that are devoured in a time of inflation. Such a scenario seems very far from reality today, but even the current super-low yields in bond markets make bond laddering attractive because the investor is not locked into the lowest of the low returns on short-term bonds. That said, if interest rates remain at historically low levels, the savvy investor might want to shorten the ladder to increase his yield-to-risk ratio that increases over time, due to inflation. Besides, one can always extend the ladder later if market conditions favor that.

Most people that practice bond laddering today purchase a mix of Treasury notes and bonds, as well as corporate and municipal bonds when that is appropriate. Issues that are actively traded and plentiful in number make for the best ingredients in bond laddering.

One hybrid version of bond laddering involves buying only short- and long-term bonds, none in intermediate lengths. These investors appreciate a mixture of the generous returns of long-term bonds while they maintain the flexibility of pulling out of the investment market as they watch some principal mature in the near term. This version of bond laddering is called the “barbell” strategy due to the heavy investment placed on each end of the bond-maturation spectrum.

The downsides of bond laddering are what you would expect: the possibility of having to sell early due to personal hardship or the bond being “called” early, bogging down your cash flow and botching up your planned maturity schedule; the risk of default, especially with corporate bonds; and, the higher outlay required for an effective ladder. Fidelity recommends $100,000 to get your ladder off the ground and to achieve the diversity and length that can prove most advantageous. If only corporate bonds are purchased, a minimum of $200,000 is recommended, to hedge against the possibility of default.

All in all, bond laddering yields an investment opportunity for moderately promising returns without much risk. It is a way to make bonds more rewarding as the time span for maturity is both lengthened and shortened, and your portfolio has an advantageous mixture of short- and long-term bonds.

“A predictable income stream?” That sounds like a definite boost to many investors today, which is why bond laddering continues to grow.

Remember…..”An Investment in Knowledge pays the best interest”.  Ben Franklin