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April 2024

Investing Basics: Bond Ladders

What is a bond ladder? And why do we build them?


Written by
 
James S. McConnel

Portfolio Manager

As a follow-up to our introductory piece on bonds, we wanted to discuss one of the most useful and common tools bond investors and their advisors employ: the bond ladder.

A Bond Ladder Defined

A bond ladder is simply a collection of individual bonds that mature on different dates, staggered, or “laddered” into the future. For example, suppose a person wants to invest $50,000 in fixed income. By using a bond ladder approach, the investor could buy five different bonds, each with a face value of $10,000. Each of those bonds would have a different maturity, with the first bond maturing next year, the second the year after, and so on.

What Is the Purpose of a Bond Ladder?

Bond ladders fulfill two key purposes: helping to minimize risks and to manage cash flows. Because different bonds can be purchased from different issuers with different maturities, the portfolio can achieve greater diversification than if an investor were to buy a large amount of a single bond. Furthermore, because bonds in the ladder mature at different intervals, they produce a relatively smooth cash stream rather than infrequent large lump sums. Proceeds from maturing bonds can be reinvested in new bonds, extending the ladder, invested opportunistically in stocks, or used to meet expected cash needs. In this way bond ladders can provide a degree of flexibility.

In addition to generating predictable streams of income and reducing exposure to volatile stocks and concentrated bond positions, bond ladders help manage the risks from changing interest rates. If interest rates increase, new longer-term bonds can be purchased at higher yields when a bond in the ladder matures. And if interest rates fall, longer-term bonds already in the ladder will continue to pay higher interest rates than the broader market. Either way, by using a bond ladder, an investor mitigates the risk of a fluctuating interest-rate environment.

How Does Mitchell Sinkler & Starr Build Ladders?

Portfolio managers at MS&S build bond ladders to meet the individual needs of each of their clients, so the length of the bond ladder will vary among clients. We select high-quality individual bonds – both corporate and municipal – of different face amounts that can be added to the ladder. Depending on the amount of funds that clients choose to invest in bonds, we often purchase numerous bonds in each maturity year of the ladder, rather than just one, further diversifying the client’s holdings. Perhaps most importantly, we spend time evaluating the credit quality of bond issuers when constructing the ladder and monitor the changing market conditions for interest rates when considering the length of the ladder.

While the process of building a bond ladder can be complex and time intensive, we have found that the benefits for clients are abundant, particularly when bonds provide attractive yields, as they do today.

 

James S. McConnel

 

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