What it is:
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%, 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 capital at 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 may be higher than purchasing one large . Second, the constant maturing does present some reinvestment risk to the investor if interest rates are falling instead of rising.