Climbing the Bond Ladder?

We humans cannot leap like squirrels. We need a ladder to climb to the roof top. A ladder helps us climb in small incremental steps. So also, in investing, we mere humans are not great market timers. Instead of timing the market with all our assets at once, it is much easier to invest incremental assets in the current opportunities. This is exactly what a bond ladder aims to accomplish.

Say, you have $100,000 to invest in a 5 step bond ladder. When you start off, you put $20,000 each in bonds that mature after 1 year, 2 years, 3 years, 4 years and 5 years. With this arrangement, you will have one bond maturing every year for the next 5 years. When one bond matures, you would invest the proceeds into another bond maturing 5 years later, thus progressing the ladder forward in time.

The laddering of bonds has many advantages:

• Access to liquid assets: Since every year there is a bond maturing, you have the option to use the proceeds in case you need to access some liquidity.
• Interest rate variability: If interest rates rise, it provides the opportunity to take advantage of the increased interest rate. When the interest rates fall, you have the option to reduce your exposure as well.
• Immunity to bond price variability: The bond ladder keeps the bond investments until the bonds mature. The market price of a bond changes with market conditions. If sold prior to maturity, the bond may be worth more or less than its original cost. The proceeds at maturity of straight bonds are known in advance at the time of investment. Waiting until the bonds mature, insulates the investor from any price fluctuations in the bonds before maturity.