For Mark Roberts’ Use: Bond ladder may sound like a funny name, but it’s actually a pretty simple investment strategy. The basic idea behind bond ladders is that the investor protects himself against changes in interest rates by purchasing bonds which have staggered maturity dates. The bonds mature at intervals, rather than all at once.
How does this help? To illustrate the idea, we’ll use the example of a five-year bond ladder. Assume you purchase five different bonds with maturity dates of one, two, three, four, and five years each. When the first bond matures at the end of one year, you purchase a new five-year bond to maintain your ladder. If interest rates have gone up over that year, you now have cash to purchase a new bond at the higher rate.
On the other hand, if rates have fallen over that time period, your initial investment is protected because only a small portion of the original amount is subject to this lower interest rate.
This strategy does not effect the risk of bonds themselves. However, utilizing a bond ladder does allow you to potentially benefit when interest rates are high. It also reduces your bond portfolio’s vulnerability to risk when interest rates fall. When you choose a bond ladder over investing in a single bond, your money stays in motion. You have access to it on a regular basis and have the power to make new decisions on how to invest it.
Aside from interest rate risk, bonds are also subject to other risks such as inflation and credit quality. The returns on bonds fluctuate with the changing market. Always talk to your financial advisor about the benefits versus risks of utilizing a bond ladder before attempting this strategy. A bond ladder can carry some benefits, but remember that investments seeking a higher return usually involve a higher risk factor.
