Definition
The term bond ladder refers to an investment strategy involving the purchase of fixed income securities with staggered maturity dates. The bond ladder strategy helps investors to manage interest rate risk and provides them with the opportunity to make a series of reinvestment decisions over time.
Explanation
The bond ladder strategy involves the purchase of fixed income securities with dissimilar maturity dates. By dividing a portfolio among a series of bonds with varying maturities, the investor can minimize interest rate risk and increase their portfolio's liquidity.
Bond laddering is achieved by purchasing a series of bonds that are evenly spaced across the investor's desired liquidity timeframe. For example, an investor may choose bonds that mature each quarter over a ten year timeframe.
Laddering also allows the investor to minimize the impact interest rates have on their portfolio, for example:
If interest rates fall, the investor will only be reinvesting a portion of their fixed income portfolio.
If interest rates rise, they can take advantage of this increase when the next bond in their portfolio reaches its maturity date.
Successfully executing a bond ladder strategy requires the following:
The investor has enough money to meet their near term needs as well as emergent issues, so they can hold the bonds to maturity.
The investor also needs to have sufficient funds to build their portfolio. Generally, a laddered portfolio will have a total value in excess of $100,000.
Purchasing bonds of investment quality (or avoiding junk bonds), since a portion of the portfolio may be held for a relatively long period of time.
Finally, the investor should not purchase bonds that are callable, since that may force them to reinvest a portion of their portfolio before the scheduled maturity date.
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