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Many retirees, when planning for their living expenses, are trying to meet two key objectives: generate ongoing income and preserve as much of their principal as possible. In many instances, the strategy of bond laddering may be helpful in pursuing both of these goals.
What Is Laddering?
A bond ladder is a portfolio of bonds1 with maturity dates that are evenly staggered so that a constant proportion of the bonds can be redeemed at par value each year. By holding bonds to maturity rather than trying to buy and sell them in the secondary market, investors may minimize the potential for losses caused by interest rate volatility and market inefficiency.
Generally speaking, there are two broad types of bond ladders. One can be implemented more or less perpetually for trusts, endowments, and other applications with extended planning horizons. Another form of bond ladder can be implemented for individuals whose personal financial plans might have a definite end-point in mind.
Perpetual Bond Laddering
This bond laddering strategy is most useful for an investor who plans to conserve investment capital indefinitely and whose need for cash flow is predictable. A typical ladder might be constructed from Treasury bonds, with one-tenth of the portfolio being redeemed and reinvested each year. Such a structure would have been considerably more productive and less volatile over the past four decades than a strategy of simply buying and rolling over short-term notes, such as three-month Treasury bills.2 Keep in mind, however, that the long bond ladder is significantly less liquid than a short bill portfolio.
Laddering With a Fixed Term in Mind
Another type of bond ladder provides a steady cash flow for a predetermined number of years. This can be done with a zero-coupon bond, a type of bond that pays all of its interest in one lump sum at maturity. Generally speaking, the further in the future that one expects to receive the redemption value, the less one needs to spend today for the bond.
A bond ladder offers a formula for allocating fixed income to potentially reduce the unique risks of bond holdings while generating a steady stream of income. Your financial advisor can help you determine whether bond laddering is an efficient solution for your needs.
1 Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.
2 Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest, and, if held to maturity, offer a fixed rate of return and fixed principal value.
© 2010 Standard & Poor’s Financial Communications. All rights reserved.
©2010, Kelly Ruggles, Spokane, WA. Web site
Kelly C. Ruggles, Spokane, WA. Is a fee-based financial planner located in Spokane.
Kelly C. Ruggles, Spokane, WA. President of American Reliance Group, Inc., a registered investment advisor.
Kelly Ruggles, Spokane, WA. Is the author of "The Financial Playbook" for Retirement
Kelly C. Ruggles, Spokane, WA. Does not intend to provide personalized investment advice through this publication and does not represent the strategies or services discussed are suitable for any investor. Investors should consult with their financial advisors prior to making any investment decisions
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