What is a Bond Ladder?
A bond ladder is a meticulously planned portfolio of fixed-income securities, each with a distinctive maturity date. By acquiring a variety of smaller bonds with staggered maturity dates rather than opting for a single large bond with one maturity date, investors can strategically mitigate interest rate risk, enhance liquidity, and diversify credit risk.
Key Points
- Risk Minimization: A diversified maturity schedule minimizes the impact of interest rate fluctuations.
- Enhanced Liquidity: Regular intervals of bond maturities ensure consistent availability of funds for reinvestment or withdrawal needs.
- Credit Risk Diversification: Owning various bonds reduces the risk related to the credit quality of individual issuers.
- Constructing an ETF Bond Ladder: Simplified by equally investing in various ETFs with defined maturity dates.
- Use of Non-Callable Bonds: Ideal for bond ladders as they protect against early redemptions by the issuer.
Understanding Bond Ladders
In a bond ladder, the bonds have maturity dates that are evenly spaced over months or years. As bonds mature, the proceeds can be usefully reinvested in the current interest rate environment. The structure enables investor flexibility depending on their liquidity needs. Closer maturity intervals serve heightened liquidity needs better.
Benefits of a Bond Ladder
Bond investors prioritize conservative income generation. Longer maturity bonds offer higher yields but come with added three-fold risks: interest rate risk, credit risk, and liquidity risk.
- Interest Rate Risk: Bond prices drop when interest rates rise. Shorter maturity bonds are less sensitive to such changes compared to longer maturity bonds.
- Liquidity Risk: Rising interest rates decrease the desirability of lower-yield bonds, reducing their liquidity. Selling when rates are high can lead to substantial losses unless prices normalize.
- Credit Risk: Large positions in a single bond expose investors to issuer-specific credit risks. Credit deterioration directly impacts bond prices, creating potential significant value drops.
Using a bond ladder effectively addresses these risks. Regular bond maturities and reinvestment, along with a diversified issuer list, spread out and thus cushion these risks. For optimal outcomes, having up to 10 ‘rungs’ or separate bonds is advisable, raising diversification, liquidity, and yield stability.
Example of a Bond Ladder
Retail investors can create a simplified bond ladder using ETFs. For instance, building a 10-year Treasury bond ladder involves investing equally across the following ETFs:
- iShares iBonds Dec 2021 Term Treasury ETF
- iShares iBonds Dec 2022 Term Treasury ETF
- iShares iBonds Dec 2023 Term Treasury ETF
- iShares iBonds Dec 2024 Term Treasury ETF
- iShares iBonds Dec 2025 Term Treasury ETF
- iShares iBonds Dec 2026 Term Treasury ETF
- iShares iBonds Dec 2027 Term Treasury ETF
- iShares iBonds Dec 2028 Term Treasury ETF
- iShares iBonds Dec 2029 Term Treasury ETF
- iShares iBonds Dec 2030 Term Treasury ETF
FAQs
Should You Build a Bond Ladder With Callable Bonds?
No, callable bonds aren’t suitable for building a bond ladder since they can be redeemed by the issuer before maturation, undermining the ladder’s stability.
How Do You Build an ETF Bond Ladder?
To construct an ETF bond ladder, allocate an equal investment across multiple ETFs, each with different defined maturity dates. For instance, a 10-year ladder could include:
- Invesco BulletShares 2021 Corporate Bond ETF
- Invesco BulletShares 2022 Corporate Bond ETF
- Invesco BulletShares 2023 Corporate Bond ETF
- Invesco BulletShares 2024 Corporate Bond ETF
- Invesco BulletShares 2025 Corporate Bond ETF
- Invesco BulletShares 2026 Corporate Bond ETF
- Invesco BulletShares 2027 Corporate Bond ETF
- Invesco BulletShares 2028 Corporate Bond ETF
- Invesco BulletShares 2029 Corporate Bond ETF
- Invesco BulletShares 2030 Corporate Bond ETF
What Are Alternatives to a Bond Ladder?
Alternative strategies include selecting ETFs that naturally hold a diversified bond portfolio with varying durations. Notable options are:
- iShares Core U.S. Aggregate Bond ETF
- Vanguard Total Bond Market ETF
- Vanguard Total International Bond ETF
- iShares TIPS Bond ETF
Related Terms: Fixed-Income Securities, Maturity Date, Interest-Rate Risk, Portfolio Diversification, Liquidity.
