Bond Ladders

Laddering is a diversification strategy that involves purchasing an assortment of bonds with various maturities. Buying a range of maturities typically reduces a portfolio's exposure to interest rate risk.

While short-term bonds usually offer a higher degree of stability, an investor may sacrifice returns which are often available from longer-term bonds. Conversely, longer term bonds may expose the investor to more volatility and the possibility of losses if sold prior to maturity.

For example, a bond ladder may consist of equal amounts of bonds maturing in two, four, six, eight and 10 years. In two years, when the first bonds mature, the investor may reinvest the money in a bond with a 10 year maturity, thereby maintaining the bond ladder portfolio.

The return on a laddered portfolio is typically higher than a portfolio of only short-term issues. The overall portfolio risk would also be less than a portfolio of only longer-term issues. When compared to buying bonds of a single maturity, the laddered approach offers potential protection against interest rate changes while providing a predictable stream of income.

If interest rates fall, the bonds that mature in two years would have to be reinvested at a lower rate. However, the other bonds in the portfolio would have an above-market return. Alternatively, if interest rates rise, the total portfolio might pay a below-market return, but the maturing bonds can be reinvested in bonds with the higher rate environment.