Global Asset Management in Seoul Korea — How to Build a Bond Ladder
Investing your hard-earned money is a big step, filled with what seems like intimidating activities especially for novice investors. However, there are available investment methods that are simple to follow and more importantly, provide a steady stream of income without risking a lot of money.
One of these investment strategies is constructing a bond ladder. If you are interested to know more about this strategy and how to build a bond ladder, then read on.
Bond Ladder: What is it?
A kind of fixed-income security, a bond is a type of investment that allows you to provide a loan to a company or the government. Fixed-income security is generally deemed as safe investments with a point of maturity. The point of maturity is when the principal amount is paid back to the investor. A bond also has a coupon rate, which represents the percentage of the principal that gets paid out at pre-determined intervals. The point of maturity is usually anywhere between a few weeks to a few months.
A bond ladder is a multi-maturity investment strategy that uses several bond holdings as part of the investor’s portfolio. The rungs on the ladder help to manage interest rates and the risk of reinvestment.
The Main Purpose of a Bond Ladder
The main purpose of creating a bond ladder is to diversify bond holdings within your portfolio. Many investors opt to build a bond ladder because it customizes a stream of income and it manages the risks of ever-changing interest rates. It also gives the investor the flexibility to invest in different credit and interest rate environments. Another purpose of a bond ladder is to give the investor liquidity. If you create a bond ladder, one portion of your portfolio is never more than a year away from maturity. Long-term bonds pay higher yields, so the proceeds from matured bonds are always reinvested at the highest possible rate.
Bond Ladder vs. Annuity
Although both are income producers, bond ladders and annuities are two different investment strategies. Annuities guarantee an income stream that will last a lifetime, while a bond ladder will make a fixed series of maturity payments until all the bond payments have been made. Annuities are usually cheaper because of its one size fits all feature, but a bond ladder offers the investor good value because they are customized according to an individual’s spending needs. In deciding whether you will pick a bond ladder vs. annuity, it depends on your financial goals.
Bond Ladder vs. Bond ETF
Although both share similar characteristics including diversification features, bond ladders and bond ETF are two different kinds of investments. A bond ETF (exchange-traded fund) packages a portfolio of bonds with varying interest yields and maturity dates into a single investment. Bond ETFs seek to duplicate various bond indices. If you plan to frequently buy and sell your holdings, then bond ETFs are a good investment choice.
Building a Bond Ladder
A trusted financial advisor can help you build a bond ladder. Here are the steps on how to do it right:
· Decide on the amount you plan to invest and divide it equally with the total number of years you plan to have a ladder. The number of bonds in your portfolio represents the number of rungs in your ladder.
· Start by investing in a variety of bonds with different dates of maturity. The duration between the maturities of each bond determines the distance between the rungs of the ladder. The number of bonds, the maturity of each bond, and securities are chosen based on your goals and current financial situation.
Hold each bond investment until they reach maturity. Once each of them reaches maturity, you can collect interest payments along the way.
When each bond matures, you can opt to reinvest in the ladder or use your funds differently.
Layered Bond Portfolio
You stagger the maturity of the bonds in a bond ladder so that as the proceeds mature they can be reinvested at regular intervals. Also called a layered bond portfolio, this is how it works: If you are going to invest $90,000 by creating a bond ladder, you could put in $30,000 in a one year bond at 5%, another $30,000 in a two-year bond at 5.25%, and the last $30,000 in a three-year bond at 5.50%. Each year is considered a rung on the ladder. When the one-year bond reaches maturity level, you have the option to reinvest the proceeds in a three-year bond. At the end of the second year, you can reinvest the proceeds you received into another three-year bond and so on.
Many financial and investment decisions can be complex and hard to understand. Although laddering bonds are a relatively “safe” investment strategy, it doesn’t eliminate rate risk and you may still face reinvestment risk at least for some portions of your portfolio. Bond ladder fees or transaction costs may also be higher compared to buying one large bond. It is wise to seek the help of professional investment advisors who give innovative and personalized wealth management solutions.