Boost Your Portfolio Return with a Bond Ladder
Money management. Risk diversification. Those are tried and true strategies for investment success. They separate the lucky from the skilled, the savvy from the hapless.
While luck is to be hoped for while investing, it’s far better to be smart than lucky, and to follow a sound strategy for boosting your portfolio return rather than trusting that “good things will happen”.
When it comes to strategies, creating a bond ladder is one of the smartest and most essential things you can do.
What’s a Bond Ladder?
Before we get too far, we need to consider what a bond ladder is. Really, it’s nothing more than a series of investments in high-quality bonds that mature at different dates.
Those staggered maturity rates ensure that you have a constant stream of income for a predictable amount of time.
It also helps to reduce your risk while managing cash flow.
Let’s say you bought 10 bonds. You’d make sure that each bond had a different maturity rate – one year from now, three years from now, five years from now, and so on.
Each maturing bond is one more rung on the ladder, helping you climb upward, toward financial security.
Why Should You Use a Bond Ladder?
Really, the benefits of laddering should be apparent, but let’s take a closer look. There are really two primary reasons to make this choice.
The first is to ensure that you’re not locked into a single bond for a long time. That would limit your financial security and liquidity, locking your wealth away and limiting your ability to capitalize on market shifts. While you’d have it on paper, you wouldn’t have it in reality.
Laddering ensures that you’re never put in that position.
Another reason is that it gives you the ability to adapt to your own changing financial needs.
For example, by choosing bonds with different coupon dates, you can create a predictable monthly flow of cash, which is a vital consideration for anyone in retirement.
However, for those who don’t need a reliable flow of cash each month, it provides access to liquidity, allowing you a buffer if something untoward were to occur – say losing your job or an unforeseen cost hitting you at an inopportune time.
How Do You Create a Bond Ladder?
It’s actually not difficult at all to create a bond ladder. Just visualize an actual ladder, with each bond as a rung.
You’ll need to know how many years your ladder will span, as well as the amount of money you have to invest. Then, simply divide your investment amount by the needed length of time, which gives you the number of bonds you need to purchase.
The more bonds purchased (with the appropriate amount of time between maturity dates), the longer you can expect a steady stream of returns, and the farther into the future you can plan with confidence.
Pay attention to the distance between the rungs, though.
Just as a ladder with a large physical distance between its rungs may be unable to be climbed, a bond ladder with too much distance between the rungs may be untenable due to increased risk and too much duration between maturity dates, which limits your access to the funds locked up in the bond.
However, resist the temptation to make the distance between rungs too short. This reduces the amount of time you have to wait for the return on your investment, but it also reduces the amount of return itself.
Choose Only Investment Grade Bonds
Now we need to talk about the materials for your bond ladder.Just as you want strong, light materials to build a physical ladder, your bond ladder needs to be made from the right stuff.
Resist the temptation to throw government bonds into the mix. Look for high-quality, investment-grade corporate bonds.
Avoid bond funds, and only invest in individual bonds from reputable companies.
Yes, there are many tempting options out there, but understand that individual, high-quality corporate bonds offer the ideal mix of risk reduction and financial return while safeguarding you from the vagaries and shifts of the marketplace.
Don’t Touch Depressed Bonds and Sectors
Make sure you avoid depressed bonds and sectors.
Those are best left to speculators and market professionals, as they carry too much risk for the average investor who only wants to safeguard their financial future and build their wealth over time.
In the End
When everything is said and done, creating a bond ladder allows you to virtually eliminate the risk of interest rate hikes and devaluation.
This is particularly important today as the Fed continues to raise interest rates, and the stock market teeters atop peak valuation, with the long descent into the abyss on the other side.
It just makes sense to protect your wealth and enjoy risk immunization.