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Bond Laddering Bond laddering is both a portfolio management strategy and a practical model for investing in fixed income. The idea behind bond laddering is to purchase multiple bonds, each with different maturity dates, in order to achieve the following goals: - Decrease interest rate risk by holding both short-term and long-term bonds, thereby spreading risk along the interest rate curve. If rates are rising, as one bond matures the funds can be re-invested into higher-yielding bonds. - Decrease re-investment risk, since, as one bond in the ladder matures, the cash is re-invested, but it only represents a portion of the total portfolio. Even if prevailing rates at the time of re-investment are lower than the previous bond was returning, the smaller amount of reinvestment dollars mitigates the risk of investing a lot of cash at a low return. - Maintain steady cash flows to encourage regular saving and maintenance for investors looking for an income-producing portfolio.
Bond laddering tends to decrease the overall risk of a fixed income portfolio for the reasons described above. The one downside is that the potential for outsized returns compared to a relevant index is limited because the investor is holding a diversified portfolio in terms of maturation dates. The type of investor who is utilizing this strategy usually has placed safety of principle and income above portfolio growth. |