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Bond Ladders: Overview, Strategy and How to Build
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Bond Ladders: Overview, Strategy and How to Build
Bond laddering is a wat to spread assets across multiple bonds with different maturity dates.
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Expertise Personal Finance investing retirementConnor Emmert is a former NerdWallet writer and an authority on investing. Prior to joining NerdWallet, he spent several years as a licensed financial advisor with Bank of America/Merrill Lynch and Fisher Investments. He earned his bachelor's degree in English at Colby College.
Connor Emmert is a former NerdWallet writer and an authority on investing. Prior to joining NerdWallet, he spent several years as a licensed financial advisor with Bank of America/Merrill Lynch and Fisher Investments. He earned his bachelor's degree in English at Colby College. Writer + more + more
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11 years of experienceChris Hutchison helped build NerdWallet's editorial operation and has directed coverage across banking, investing, taxes and insurance. He now leads a team exploring new verticals. Before joining NerdWallet, he was an editor and programmer at ESPN and an editor at the San Jose Mercury News.
Chris Hutchison helped build NerdWallet's editorial operation and has directed coverage across banking, investing, taxes and insurance. He now leads a team exploring new verticals. Before joining NerdWallet, he was an editor and programmer at ESPN and an editor at the San Jose Mercury News. Head of Content, New Verticals + more + moreWhat is a bond ladder?
What is a bond ladder?A bond ladder is an investing strategy in which the investor buys multiple bonds with different maturity dates in order to create a diversified source of fixed income that mitigates interest rate risk and liquidity risk.
A bond ladder is an investing strategy in which the investor buys multiple bonds with different maturity dates in order to create a diversified source of fixed income that mitigates interest rate risk and liquidity risk.When investors purchase a bond, they are effectively lending money to the issuer for a fixed length of time in exchange for annual interest payments at a rate determined at the beginning of the term. But over the course of three years, 10 years or especially longer, the interest rate environment and other factors can shift and negatively affect a bond's value.
When investors purchase a bond, they are effectively lending money to the issuer for a fixed length of time in exchange for annual interest payments at a rate determined at the beginning of the term. But over the course of three years, 10 years or especially longer, the interest rate environment and other factors can shift and negatively affect a bond's value.To offset some of these risks, many investors use bond ladders. By spreading their bond purchases across different maturity lengths, investors can get short-term liquidity to help manage cash flow and protect against fluctuations in interest rates.
To offset some of these risks, many investors use bond ladders. By spreading their bond purchases across different maturity lengths, investors can get short-term liquidity to help manage cash flow and protect against fluctuations in interest rates. Advertisement1
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Financial Planning Retirement Planning Investment Management Tax Strategy OtherHow bond ladders work
How bond ladders workHere are the basic steps to building a bond laddering strategy.
Here are the basic steps to building a bond laddering strategy.Determine the length of time you’d like to invest and how frequently you want access to cash (monthly, annually, etc.).
Determine the length of time you’d like to invest and how frequently you want access to cash (monthly, annually, etc.).Select bonds that sequentially increase in their maturity date, with each bond considered a rung of the ladder.
Select bonds that sequentially increase in their maturity date, with each bond considered a rung of the ladder.As bonds mature and you receive your principal back, either take the cash or use it to purchase a new long-term bond (“re-ladder”).
As bonds mature and you receive your principal back, either take the cash or use it to purchase a new long-term bond (“re-ladder”).» MORE: Learn more about how the bond market works
» MORE: » MORE: Learn more about how the bond market works Learn more about how the bond market worksBond laddering example
Bond laddering exampleLet’s say you have $50,000 to invest over five years, and you want access to cash each year. Instead of buying one five-year bond for $50,000, you could diversify your portfolio by purchasing five $10,000 bonds that mature at one-year intervals. Take a look at the example below.
Let’s say you have $50,000 to invest over five years, and you want access to cash each year. Instead of buying one five-year bond for $50,000, you could diversify your portfolio by purchasing five $10,000 bonds that mature at one-year intervals. Take a look at the example below.The investor purchased five bonds that each mature one year apart, beginning with Bond A, a one-year bond with a coupon rate of 1%. Generally speaking, coupon rates are higher for bonds with longer maturity dates, which is why Bond E — a five-year bond — has a coupon rate of 3.5%.
The investor purchased five bonds that each mature one year apart, beginning with Bond A, a one-year bond with a coupon rate of 1%. Generally speaking, coupon rates are higher for bonds with longer maturity dates, which is why Bond E — a five-year bond — has a coupon rate of 3.5%.In year two, Bond A has matured and the principal investment of $10,000 has been returned to the investor. Meanwhile, interest rates for five-year bonds have gone up to 4%, so the investor decided to re-ladder and use the proceeds from Bond A to purchase Bond F with five years to maturity. Bond F becomes the new top rung of the ladder, and each year as the next bond matures the investor can either keep the proceeds or reinvest in a new five-year bond.
In year two, Bond A has matured and the principal investment of $10,000 has been returned to the investor. Meanwhile, interest rates for five-year bonds have gone up to 4%, so the investor decided to re-ladder and use the proceeds from Bond A to purchase Bond F with five years to maturity. Bond F becomes the new top rung of the ladder, and each year as the next bond matures the investor can either keep the proceeds or reinvest in a new five-year bond.» MORE: Learn about corporate bonds and how they're structured
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Financial Planning Retirement Planning Investment Management Tax Strategy OtherRisks of a bond ladder
Risks of a bond ladderTwo fundamental risks of a bond ladder are interest rate risk and liquidity risk.
Two fundamental risks of a bond ladder are interest rate risk and liquidity risk.Interest-rate risk is the risk that market interest rates will rise, causing the bond to become relatively less attractive to (and thus less valuable than)competing bonds that have a higher coupon rate. Bond prices and interest rates have an inverse relationship, meaning that when interest rates rise, bond prices fall. So if interest rates for 10-year bonds go from 3% to 5% while you are holding the bond, you may be stuck earning the relatively low interest rate of 3% until the bond matures.
Interest-rate risk Interest-rate risk is the risk that market interest rates will rise, causing the bond to become relatively less attractive to (and thus less valuable than)competing bonds that have a higher coupon rate. Bond prices and interest rates have an inverse relationship, meaning that when interest rates rise, bond prices fall. So if interest rates for 10-year bonds go from 3% to 5% while you are holding the bond, you may be stuck earning the relatively low interest rate of 3% until the bond matures.Liquidity risk is the risk that you can’t sell your bond for a profit. For example, you could try to sell your bond to another investor, but other investors may not be willing to pay $10,000 to get 3% when they could purchase a new bond and get 5%. You may have to sell your bond at a discount, meaning you may not get your principal investment of $10,000 back unless you wait until the bond matures.
Liquidity risk Liquidity risk is the risk that you can’t sell your bond for a profit. For example, you could try to sell your bond to another investor, but other investors may not be willing to pay $10,000 to get 3% when they could purchase a new bond and get 5%. You may have to sell your bond at a discount, meaning you may not get your principal investment of $10,000 back unless you wait until the bond matures.Institutions that issue bonds must undergo a review from a credit rating agency. The three major agencies are Standard & Poor’s, Moody’s and Fitch. These agencies take a close look at each institution’s financial standing and provide a rating based on how likely it is that the institution will meet its debt obligations to bondholders.
Institutions that issue bonds must undergo a review from a credit rating agency. The three major agencies are Standard & Poor’s, Moody’s and Fitch. These agencies take a close look at each institution’s financial standing and provide a rating based on how likely it is that the institution will meet its debt obligations to bondholders.The highest rating these agencies offer is AAA, or “triple-A.” The lowest rating is D, which indicates that an institution is at high risk of defaulting on its payments to bondholders.
The highest rating these agencies offer is AAA, or “triple-A.” The lowest rating is D, which indicates that an institution is at high risk of defaulting on its payments to bondholders.Between these two ends of the spectrum, bond ratings fall into two categories: investment grade and noninvestment grade.
Between these two ends of the spectrum, bond ratings fall into two categories: investment grade and noninvestment grade.Investment-grade bonds are generally from issuers in good financial standing with a low risk of default.
Investment-grade bonds are generally from issuers in good financial standing with a low risk of default.Noninvestment-grade bonds (also called high-yield bonds) are generally from issuers with a high risk of default. To attract investors, noninvestment-grade bonds generally offer higher interest rates to compensate for the additional risk.
Noninvestment-grade bonds (also called high-yield bonds ) are generally from issuers with a high risk of default. To attract investors, noninvestment-grade bonds generally offer higher interest rates to compensate for the additional risk.Investment-grade bonds generally make for better bond ladders. If one of your bonds defaults, you’ll be missing a rung of your ladder, and that throws a wrench into your fixed-income strategy.
Investment-grade bonds generally make for better bond ladders. If one of your bonds defaults, you’ll be missing a rung of your ladder, and that throws a wrench into your fixed-income strategy.Investment-grade bond ratings
Investment-grade bond ratings Investment-grade bond ratings Investment-grade bond ratingsMoody's
Moody's Moody'sStandard & Poor's
Standard & Poor's Standard & Poor'sFitch
Fitch FitchWhat the grade means
What the grade means What the grade meansAaa.
Aaa.AAA.
AAA.AAA.
AAA.Highest quality, minimal risk.
Highest quality, minimal risk.Aa.
Aa.AA.
AA.AA.
AA.High quality, very low risk.
High quality, very low risk.A.
A.A.
A.A.
A.High/Medium quality, low credit risk.
High/Medium quality, low credit risk.Baa.
Baa.BBB.
BBB.BBB.
BBB.Medium grade, moderate credit risk.
Medium grade, moderate credit risk.Non-investment-grade bond ratings
Non-investment-grade bond ratings Non-investment-grade bond ratings Non-investment-grade bond ratingsMoody's
Moody's Moody'sStandard & Poor's
Standard & Poor's Standard & Poor'sFitch
Fitch FitchWhat the grade means
What the grade means What the grade meansBa.
Ba.BB.
BB.BB.
BB.Substantial credit risk.
Substantial credit risk.B.
B.B.
B.B.
B.High credit risk.
High credit risk.Caa.
Caa.CCC.
CCC.CCC.
CCC.Low quality, very high credit risk.
Low quality, very high credit risk.Ca.
Ca.CC.
CC.CC.
CC.In or near default, some prospect of recovery.
In or near default, some prospect of recovery.C.
C.C.
C.C.
C.Moody's lowest rating, typically in default with little prospect of recovery.
Moody's lowest rating, typically in default with little prospect of recovery.C.
C.D.
D.D.
D.In default, also used when bankruptcy has been filed.
In default, also used when bankruptcy has been filed.Bond ladders and interest rates
Bond ladders and interest ratesThe previous example raises the question: In year one, if you can get 3% for a five-year bond but only 2% for a one-year bond, why not just put all $50,000 into a five-year bond to get more interest?
The previous example raises the question: In year one, if you can get 3% for a five-year bond but only 2% for a one-year bond, why not just put all $50,000 into a five-year bond to get more interest?The answer is liquidity and interest rate risk. If you invest all $50,000 in a five-year bond, you’re tying up that money for five years (unless you sell the bond). Depending on interest rate movements, selling could result in a loss. By laddering the bonds, the investor in this example was able to take advantage of the higher interest rate of 4% over five years when they purchased Bond F.
The answer is liquidity and interest rate risk. If you invest all $50,000 in a five-year bond, you’re tying up that money for five years (unless you sell the bond). Depending on interest rate movements, selling could result in a loss. By laddering the bonds, the investor in this example was able to take advantage of the higher interest rate of 4% over five years when they purchased Bond F.On the flip side, say interest rates for five-year bonds had fallen to 1%. In this case, the investor might decide to keep the proceeds when Bond A matures or invest in something else that could yield a higher return.
On the flip side, say interest rates for five-year bonds had fallen to 1%. In this case, the investor might decide to keep the proceeds when Bond A matures or invest in something else that could yield a higher return.» Interested in giving a bond as a gift? Read all about savings bonds
» Interested in giving a bond as a gift? » Interested in giving a bond as a gift? Read all about savings bonds Read all about savings bondsBond laddering is complex
Bond laddering is complexBond laddering can be complicated, and it requires a firm grasp of the bond markets, as well as the risks involved. If you're considering a laddered bond strategy, be sure to consult with a financial advisor to ensure you're making educated decisions about your portfolio.
Bond laddering can be complicated, and it requires a firm grasp of the bond markets, as well as the risks involved. If you're considering a laddered bond strategy, be sure to consult with a financial advisor to ensure you're making educated decisions about your portfolio.» MORE: See our picks for the year’s best wealth managers
» MORE: » MORE: See our picks for the year’s best wealth managers See our picks for the year’s best wealth managers About the author Connor Emmert Connor Emmert Connor Emmert is a former NerdWallet writer and an authority on investing. Prior to joining NerdWallet, he spent several years as a licensed financial advisor with Bank of America/Merrill Lynch and Fisher Investments. He earned his bachelor's degree in English at Colby College. See full bio.ON THIS PAGE
What is a bond ladder? What is a bond ladder? How bond ladders work How bond ladders work Bond laddering example Bond laddering example Risks of a bond ladder Risks of a bond ladder Bond ladders and interest rates Bond ladders and interest rates Bond laddering is complex Bond laddering is complexON THIS PAGE
What is a bond ladder? What is a bond ladder? How bond ladders work How bond ladders work Bond laddering example Bond laddering example Risks of a bond ladder Risks of a bond ladder Bond ladders and interest rates Bond ladders and interest rates Bond laddering is complex Bond laddering is complex More like this Investment Basics Investing Bonds How Much Does a Financial Advisor Cost? Most financial advisors charge based on how much money they manage for you. Fees are typically 1% a year but can be lower. 2 By Andrea Coombes, Taryn Phaneuf Do You Need a Financial Advisor? 7 Ways to Tell You may need a financial advisor if you're facing big life changes, don't have financial goals, have complex compensation, high tax bills or for other reasons. Taryn Phaneuf How to Find Cheap or Free Financial Advice Quality financial advice is more accessible than ever — and much of it is free or inexpensive. Here's how to get it. June Sham 3 Steps to Prepare for Your First Financial Advisor Meeting Here's what think about and bring to your first meeting with a financial advisor. June Sham