Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Bond Ladder

What it is:

A bond ladder is an investment strategy whereby an investor staggers the maturity of the bonds in his/her portfolio so that the bond proceeds mature and can be reinvested at regular intervals.

How it works (Example):

For example, say you have $75,000 to invest. To create a bond ladder, you could invest $25,000 in a one-year bond at 6%, $25,000 in a two-year bond at 6.25%, and $25,000 in a three-year bond at 6.50%. Each year is considered a "rung" on the ladder.
 
Now, when the one-year bond matures, you would reinvest the proceeds in a three-year bond. At the end of the second year, you would put the proceeds from the matured two-year bond into a three-year bond, and so on. Here is how the strategy, using sample data, looks visually:

Why it Matters:

There are several advantages to bond laddering, and many bond fund managers use this strategy. The first advantage is that bond laddering can allow investors to benefit from increases in interest rates because the investor is able to reinvest the maturing portion of his or her capital at market rates. Second, the diversification inherent in laddering can help stabilize the investor's income stream. Third, laddering gives the investor liquidity because a portion of the portfolio is never more than a year away from maturity.

There are some drawbacks to laddering, however. First, the transaction costs of purchasing several bonds may be higher than purchasing one large bond. Second, the constant maturing does present some reinvestment risk to the investor if interest rates are falling instead of rising.

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