Bond Laddering: A Conservative Investment Strategy for a Rising Interest Rate Environment

Last year, 2022, served as a regime change for investors. We faced a macroeconomic environment we hadn’t seen since the late 1970s: Inflation was high, interest rates were rising, and the stock market was declining.

In this kind of environment, it can be challenging to find investment options that offer both stability and growth. However, a bond ladder is a tried-and-true strategy that can help investors navigate these waters. A bond ladder is a diversified portfolio of bonds (typically government) with staggered maturity dates, allowing for a steady stream of income and the opportunity to reinvest at higher interest rates as bonds mature.

To understand how a bond ladder works, consider an example of an investor with $500,000 to invest. Instead of investing the entire sum into a single bond, the investor splits it into five equal parts and invests in bonds with maturity dates of one, two, three, four, and five years.

Note: This strategy also works with shorter-duration bonds, with maturities of less than one year, but for this article, we will focus on more intermediate-term bonds with maturities longer than one year.

As each bond matures, the investor receives the face value of the bond and the interest earned, and can then invest in a new bond with a longer maturity date and a potentially higher interest rate.

Advantages of a Bond Ladder

The advantages of a bond ladder are twofold. First, a bond ladder provides a stable source of income as each bond matures, which can be particularly attractive in a rising interest rate environment where fixed-income investments such as bonds may offer lower returns. Second, a bond ladder allows investors to take advantage of higher interest rates as they become available by reinvesting in longer-term bonds.

Let’s look at a numerical example to see the potential benefits of a bond ladder. Assume that the investor described above invested in bonds with the following interest rates:

Year 1: 3.50%
Year 2: 4.00%
Year 3: 4.50%
Year 4: 5.00%
Year 5: 5.00%

At the end of year one, the investor would receive $3,500 in interest and the face value of the bond, totaling $100,000:

The investor would then take that money received and invest it back into a five-year bond at hopefully higher interest rates.

As this example illustrates, a bond ladder can provide a stable source of income and the opportunity to benefit from rising interest rates.

Is a Bond Ladder Right for You?

A bond ladder is a conservative investment strategy that can be valuable for investors seeking stability and growth in a rising interest rate environment. While it may not offer the potential for higher returns that other investment options do, it can provide a steady stream of income and the opportunity to reinvest at higher interest rates as bonds mature.

Before investing in a bond ladder, it is important to seek advice from a fee-only financial advisor to ensure that it is the right strategy for your financial goals and risk tolerance. Our financial planning firm in Claremont, CA, helps clients determine whether bond ladders can benefit them as part of their ongoing financial planning.

Schedule a call with a fee-only financial advisor to discuss your situation and how we might help.

This material was generated using artificial intelligence (ChatGPT) and edited by RPA Wealth Management and Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax, or legal advice.