Bond Ladder Investing
A bond ladder is a bond investing strategy under which the investor purchases a number of bonds that mature at regular intervals in an effort to minimize the risks associated with investing in fixed-income securities. The strategy is also employed to manage cash flows by matching the timing of these flows with the investor’s demands for cash. Depending on the need, income payments can be scheduled for monthly, quarterly, or semi-annual payments. By combining these instruments, the investor maximizes return (through the longer-term issues) while minimizing risk (through the shorter-term issues).
The Steps to Creating a Bond Ladder
To implement a bond ladder strategy, the investor would invest equal amounts of money in securities that are scheduled to mature in periods varying time periods. The components of the strategy include:
Materials: The materials for the bond ladder can include different types of fixed-income securities, including government bonds, municipal bonds (“Munis”), corporate bonds and certificates of deposit (CDs). It is generally advised that callable bonds not be included in the mix.
Rungs: To arrive at the total number of rungs (bonds) for the ladder, you would decide on your starting investment amount and divide it equally by the number of years for the ladder. The greater the number of rings, the more diverse your portfolio will be and the more downside protection it will provide.
Height: The distance between the rungs reflects the amount of time between maturity dates of the various bonds in your ladder, typically anywhere from a couple of months to several years. This will indicate your risk v. return decisions; with longer distances reflecting a higher return probability and greater risk potential.
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Potential Benefits of a Bond ladder Strategy
Higher Average Yields: By including longer-term instruments within the portfolio mix, a bond ladder can increase an investor’s return.
Decreased Investment Risk: Including shorter-term instruments in the portfolio can decrease an investor’s risk exposure and provide an element of stability.
More Stable Returns: Bond ladders, with their mix of fixed-income instruments, can help the investor achieve a more consistent yield as interest rates fluctuate.
Cash Flow Management: Bond ladders can be constructed in such a way as to provide investors with income that meets the timing of their cash needs.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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