Income Stream & Maturity
For a bond investor seeking a stable income, bond laddering is the best strategy. A ladder strategy minimizes the effects of fluctuations in interest rates on the value of the portfolio. It also provides a steady cash flow.A bond ladder is a portfolio consisting of bonds with different maturities.
For example, suppose an investor has $100,000 to invest. With the ladder approach, the investor could buy 10 different bonds with face values of $10,000. Each bond, however, would have a different maturity. One bond could mature in one year, another in two years and the others every year spaced out evenly over the remaining eight years. It is called a ladder strategy because the maturities appear to be spaced out like the rungs of a ladder.
Two reasons to use the ladder strategy are:
- By laddering the maturity dates, you won't be locked into one particular bond for a long duration. A problem with locking yourself into a bond for a long period of time is that you can't protect yourself from fluctuations in interest rates. Suppose you invested the entire $100,000 into one bond with a coupon of 5% and maturity of 10 years, it wouldn't be possible to take advantage of increasing or decreasing interest rates during the 10 year interval. By using a bond ladder, fluctuations in the market are smoothed out because a bond is maturing every year.
- The second reason for using a bond ladder is that it provides investors with the ability to adjust cash flows to match their income requirements. With the $100,000 investment, you can get a monthly income based upon the coupon payments from the laddered bonds by picking ones with different coupon dates. This is particularly important for retirees who depend on a reliable periodic income.