What is a Bond Ladder and Should I Make One?
A bond ladder is a portfolio of individual CDs or bonds that mature on different dates. This strategy is designed to provide current income while minimizing exposure to interest rate fluctuations. Instead of buying bonds that are scheduled to mature during the same year, you purchase CDs or bonds that mature at staggered future dates.
Why Should I Create a Bond Ladder?
Manage Interest Rate Risk
By staggering maturity dates, investors avoid getting locked into a single interest rate. A ladder helps smooth out the effect of fluctuations in interest rates because there are bonds maturing every year, quarter, or month, depending on the number of rungs in the ladder. When a bond matures, an investor could reinvest that principal in a new longer-term bond at the end of a ladder. If interest rates have risen, they’ll benefit from a new, higher interest rate and keep the ladder going. If interest rates were to fall, unfortunately the maturing bonds would likely be reinvested at lower rates, but the bonds at the end of the ladder will have likely locked in higher yields already.
Manage Cash Flow
Since many bonds pay interest twice a year on dates that generally coincide with their maturity date, investors can structure predictable monthly bond income based on coupon payments with different maturity months as well as years.
How is a bond ladder created?
The overall length of time, spacing between maturities, and types of securities are primary considerations when building a bond ladder. Even in a low or rising interest rate environment, bond ladders can help to balance the need for income while managing interest rate risk.
Take the total amount that you plan to invest, with the goal of extending the ladder as long as possible. For example, $100,000 to buy individual bonds could be invested with 10 rungs of $10,000 each.
An additional benefit to having at least six rungs is that an investor can create a ladder structured to generate income every month of the year.
Just like a real ladder, investors can build their ladders with different materials; in other words, different types of bonds or CDs. Moreover, investors can also utilize the potential tax advantages of municipal bonds, the credit guarantee of U.S. Treasuries, or the generally higher yields of investment-grade corporate bonds.
Considerations
The more liquidity an investor needs, the closer together their bond maturities should be.
One significant downside to bond ladders is the potential for lower returns compared to other investment options like equities. Bonds, particularly high-quality ones like government securities, typically offer lower yields than equities or other higher-risk investments.
Another downside is the impact of inflation on fixed-income investments. Bond ladders generally consist of bonds with fixed interest payments, which can lose purchasing power over time due to inflation.
Modern Alternatives & Tools
Bond ladder ETFs: Funds like iShares iBonds or defined-maturity ETFs automatically manage ladders—they reinvest proceeds when bonds mature.
Robo-advisors: Platforms such as Wealthfront now let investors build ladders (e.g., U.S. Treasuries) with low minimums (~$500) and small fees.
Advisory Tools: Firms like J.P. Morgan offer tools to customize ladder strategies based on clients' needs.
