Laddered Bond Strategy

There are lots of reasons why people invest their savings, but most of them share the same goal: to earn more from their cash.

For investors seeking a higher return while minimizing risk, one option is a laddered bond strategy.

Investing in bonds is a way to generate a steady flow of coupon payments - usually paid semi-annually - while avoiding the risks that come with the ups and downs of the stock market.

Bonds are by no means risk-free - no investment truly is. They come with their own inherent uncertainties.

Will interest rates rise in the future and lower the bond price? How easily can you sell the bond if, for some reason, you need cash? What if the issuer is unable to pay back the principal?

These are common concerns when investing in bonds.

One way to mitigate these risks while providing a regular, predictable source of income is through a laddered bond strategy.

What is a laddered bond strategy?

A laddered bond strategy, or bond ladder, consists of buying bonds with different maturity dates. It is a way to build liquidity into a portfolio while providing a more predictable yield.

The simplest laddered strategy is to purchase a group of investments with different terms at one time. This way there will be a regular stream of maturity dates.

The most common laddered strategy is to purchase investments with the same term at regular intervals, resulting in different maturity dates. For example, you could buy one-year bonds at the beginning of each quarter. This strategy is referred to as a “rolling ladder”.

Laddered portfolios takes the guessing game out of fixed-income investing. For instance, if short-term bonds mature at a time when market conditions are unfavorable, the principal amount can be reinvested in a longer term, and vice-versa.

Benefits of a laddered bond portfolio

Reduced interest rate risk

Medium and long-term bond investors often try to look ahead to predict which way interest rates are going to go. The longer the term, the more difficult it becomes to make the right call.

With the former option, unless you buy a floating rate bond, the interest you earn is fixed for the bond’s term. So if interest rates rise, you cannot take advantage of the higher rates – except by reinvesting the interest you receive.

With a laddered strategy, investments are spread out over time so interest rate volatility is flattened.

Liquidity

Investing a lump sum in a single bond means your money is locked away until it reaches maturity unless you decide to sell. However, if interest rates go up and you want to sell the bond, you could end up losing money because of the inverse relationship between interest rates and bond prices.

With a laddered strategy, investors are rewarded with regular and predictable cash flows. They can choose whether to reinvest the money, depending on market conditions.

Diversification

A bond ladder mitigates some of the inherent risks of bond investing through diversification. Investing in a single issuer means you face a greater credit risk. A portfolio made up of bonds from several issuers, on the other hand, reduces your exposure in the unlikely event an issuer is unable to pay back a bond.

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Example

The most simple “laddered” strategy is to purchase a group of investments, all with different terms at one time. This spreads out maturity dates, as below:

The most common laddered strategy is to purchase investments with the same term at regular intervals, resulting in different maturity dates. This strategy is sometimes referred to as a “rolling ladder”:

Bottom Line

A laddered bond strategy is a way to mitigate factors like interest rate risk, reinvestment risk, credit risk and liquidity risk.

It allows investors to effectively balance the need for liquidity along with the opportunity to earn a higher rate of return.

By allocating funds into bonds that have different terms or maturity dates, investors have the option to allocate the funds back into the ladder if market conditions are more favourable.

If you have any questions about Laddered Bond Strategy, you can call us at 604-643-0101 or email cashgroup@cgf.com.