Is a Bond Ladder a Good Investment?

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Is a Bond Ladder a Good Investment?

There are many different approaches that people tend to take when it comes to bond investment strategies, but a bond ladder seems to be a popular format that individual investors tend to use when tracking and earning interest.

Deciding what is right for you isn’t as easy as just picking a bond that looks good on paper. There are hidden fees, interest rate fluctuations, and many other things that can affect your performance.

However, bond ladders have emerged as a way to mitigate as many risks as possible, but is a bond ladder a good investment? That’s what we’ll be talking about in detail in this article, so carry on reading to see if it’s right for you.

 

What is a Bond Ladder?

A bond ladder is a strategy used in investing where you spread out your money across different bonds with staggered maturity dates. Imagine a ladder, with each crosspiece representing a bond with a different maturity date. Some bonds mature sooner, while others mature later. As each bond matures, you reinvest the money into a new bond, ideally at higher interest rates if available.

This approach helps to balance risk and return because you have a steady stream of bonds maturing and potentially providing cash flow while also keeping your money invested for the long term. It’s like having steps on a ladder, ensuring a steady climb towards your investment goals.

As wealthy investor JL Collins once said in his interview with Google, “time in the market is more powerful than timing the market,” and this process prides itself on stopping investors from trying to time the market but instead helping them ride out interest rate changes.

 

How Are Bond Ladders Created?

Bond ladders are created with a simple and minimalistic approach and only three steps: the length of time and how much you plan to invest (rungs), the spacing between the maturity dates, and the types of bonds you invest in. Let’s explore them in more detail below:

 

1. Rungs

To figure out how many bonds you need for your ladder, divide the total amount you want to invest by the number of years you want the ladder to cover. This gives you the number of bonds you should aim for in your portfolio, or, in other words, the number of rungs on your ladder.

(A quick example:) I want to invest £50,000 for 10 years, meaning I could have 10 different rungs at £5000 each, totalling £50,000 over a 10-year period.

If you have more rungs, you will have a more diversified portfolio of bonds and will be better protected.

 

2. Spacing Between Maturity Dates

However many rungs you decide to choose will determine the number of maturity dates you will have. The spacing between these dates will depend on the length of time your bond lasts, which is typically either months or years before it matures.

If you make the spacing between the rungs small, you will earn less on the ladder, but you will always have more access to your money. Whereas, on the other side, if you make the spacing further between the bonds, you will earn more in interest but have less flexibility in accessing the funds.

 

3. Types of Bonds You Invest in (Materials)

Similar to a ladder in real life, this digital ladder allows you to build yours with different types of bonds or CDs (certificates of deposit). Investing in different types of bonds from different companies allows you to mitigate risk as much as possible.

Yet, you must be aware that the bonds in your ladder shouldn’t be able to be cashed in by the issuer, as this can remove multiple rungs from your ladder, harming your spacing and results.

 

What Are the Main Goals of a Bond Ladder?

 

1. Providing You With Stability and Income

The primary goal of a bond ladder is to provide you with stability and a consistent income stream. By spreading your investments across bonds with staggered maturity dates, you will have a steady flow of cash as the bonds mature and your funds are reinvested. This helps to mitigate the risk of relying on only one bond or maturity date for income.

 

2. You Can Manage Risk Through Diversification

Another benefit of a bond ladder is that it helps manage risk through diversification. By investing in bonds with different maturity dates, you can spread out your risk exposure.

This diversification can help protect against interest rate risks, as you will be dollar cost averaging during times of high and low interest rates, ultimately meaning that you’ll be growing with the economy.

 

3. To Preserve Your Money and Grow

Additionally, bond ladders aim to help preserve your money while also providing growth opportunities. By reinvesting proceeds from maturing bonds into new ones, you can potentially capture interest rates rising over time, leading to increased income and portfolio growth, as we spoke about in the last point.

 

Should You Invest in a Bond Ladder?

Although building a bond ladder isn’t the highest-yielding form of investment and won’t meet your income needs, we believe bond ladders are a good investment if you want a secure, steady rate of return, little risk, and to grow with the changing interest rate environment without stress or worry.

Bond investments are often suited to the more mature investor who has little room for error and needs secure returns. However, we would advise that, if you’re a younger investor, you look at something like stocks and index funds as a form of investment instead.

 

Bond Ladder FAQs

 

What is the best length for a bonder ladder?

Generally speaking, anything above 6 rungs is the best length of your bond ladder, as this can ensure that you can receive interest payments for every month of the year, your level of diversification is on track, and your chance of higher-yielding returns on an equal basis is much higher.

 

Is a bond ladder better than an annuity?

If you’re someone who wants more flexibility with their funds and wants access to it more often than not, a bond ladder will be better than an annuity. On top of that, bonds typically yield higher returns than annuities, but this is not always the case with changing interest rates and different companies being part of the overall portfolio.

 

Is a bond ladder better than a bond fund?

In short, there are lots of different factors that affect whether a bond ladder or bond fund is better. Bond ladders require more effort as they’re individual bonds and bond funds will save you time due to automatic diversification. However, others feel as though bonds are one of the only types of investments where more effort will equal better results, unlike stocks.

The decision is ultimately down to your personal needs and wants, so if you want to spend less time choosing, bond funds will be a great option. Yet, if you want more ownership and a place to add multiple individual companies into your basket with different maturity dates and yield returns, bond ladders may be the better alternative.

Are you searching for investments which outperform bank interest rates?​

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