Invest
What is bond laddering?
Bond laddering is a fixed income investment strategy that allows investors to decrease their exposure to interest rate risk over the long term.
What is bond laddering?
Bond laddering is a fixed income investment strategy that allows investors to decrease their exposure to interest rate risk over the long term.
Investors and fund managers usually employ the bond laddering strategy to spread out their risk when interest rates fluctuate, or simply as a defensive measure in case some of their selected bonds present a higher risk of defaulting.
Some investors also favour the bond laddering strategy because it retains the liquidity they tend to lock away when investing in long-term bonds.
The steady progression of maturing bonds during the portfolio’s time horizon allows investors to reinvest or spend the income they regularly receive from the bonds.
How bond ladders work
Unlike the bond barbell strategy, which forces a bond portfolio to be heavily weighed on both sides by investing only in short and long-term bonds, bond ladders ensure that the investor will earn income throughout the portfolio’s life.
For example, Phil sets aside $50,000 to build his 20-year bond portfolio. Phil can either buy $50,000 worth of 20-year bonds or employ the bond laddering strategy by purchasing a variety of bonds with different maturities.
If Phil uses the bond laddering strategy, he could divide his principal investment into five equal portions to invest in five different bonds. When the first bond matures, Phil could keep his earnings or reinvest it either in the next maturing bond or in a new bond with a different maturity. He can continue this process until his 20-year time horizon is up and his last bond matures.
The table below illustrates Phil’s portfolio, according to these three assumptions:
- Phil purchases bonds with annual payouts and holds them to maturity;
- Bond maturities are spread out over one, three, five, 10 and 20 years; and
- He redeems coupon payments instead of reinvesting them.
| Principal = $10,000 | 1-year bond | 3-year bond | 5-year bond | 10-year bond | 20-year bond |
| Coupon rate | 2% | 3% | 4% | 5% | 6% |
| Annual coupon payment | $200 | $300 | $400 | $500 | $600 |
| Investment value upon maturity |
$10,200 |
$10,900 |
$12,000 |
$15,000 |
$22,000 |
From coupon payments alone, the laddering strategy would give Phil an income of $20,100 over a period of 20 years from his five different bonds. If Phil simply invested the full $50,000 in the 20-year bond, he would have earned only $12,000 ($600 x 20) when the bond matures after 20 years – an $8,100 difference!
Bond laddering isn’t for everyone
As shown above, the bond laddering strategy seems more beneficial than simply holding a long-term bond to maturity. However, interest rate movements can make the situation complicated.
Ladders could also end in a loss or smaller income for any investor, especially those who aren’t well versed in the investment market. Hiring a professional to manage the bond ladder, on the other hand, triggers management fees that could make their gains smaller or negligible.
It’s best that investors speak to a licensed professional before applying any investment strategy to ensure that the strategy matches their objectives and risk appetite. Likewise, searching for alternative strategies for fixed income investments is also recommended.
Note: The figures in the examples above are for illustration purposes only and does not consider fees and taxes that may apply when investing in bonds.
About the author
About the author
Bonds
Sustainable bonds tipped to exceed US$1.5tn in 2022
The sustainable bond market is forecast to grow while overall bond issuance stagnates. ...Read more
Bonds
Corporate bond market review makes 12 recommendations to enhance investment
Twelve recommendations have been made to support the development of a more active corporate bond market in Australia. ...Read more
Bonds
Common mistakes in buying bonds that investors should avoid
The bond market is considered as a safe haven for Aussie investors and it’s easy to see why. ...Read more
Bonds
Student files lawsuit over government bonds
A 23-year-old student has filed a lawsuit against the Australian government after alleging that it failed to disclose climate change-related risks to investors in the country’s sovereign bonds. ...Read more
Bonds
Bonds in the ‘new normal’ – navigating a recession
Dampening downside risk during a global economic downturn requires active management and informed decisions, writes Justin Tyler. ...Read more
Bonds
Buyers beware of silent risks in bond markets
Investors are being urged not to fall into the trap of buying inferior-quality bonds in a low-yielding environment, despite the promises of higher returns, an industry expert has warned. ...Read more
Bonds
Reasons to invest in government bonds
Many investment experts recommend adding government bonds to an investment portfolio in order to reap its benefits while limiting risks and losses. ...Read more
Bonds
What is credit investing and how does it work?
A well-diversified investment portfolio typically includes credit investments to balance risk and return. Here’s what you need to know about credit investing and how it works. ...Read more
Wrapping up an eventful 2021
Listen now
What Omicron means for property, and are units right for first-time buyers? What is equity crowdfunding? Are industry super funds tapping into member funds to save their skins?
Listen now
Will housing affordability improve in 2022? Will buy now, pay later become the norm? Why are Aussies staying in failing super products?
Listen now
Who really benefits from crypto ETFs? How will the RBA respond to rising inflation? Could a mandate help address unpaid super?
Listen now
Bonds
Sustainable bonds tipped to exceed US$1.5tn in 2022
The sustainable bond market is forecast to grow while overall bond issuance stagnates. ...Read more
Bonds
Corporate bond market review makes 12 recommendations to enhance investment
Twelve recommendations have been made to support the development of a more active corporate bond market in Australia. ...Read more
Bonds
Common mistakes in buying bonds that investors should avoid
The bond market is considered as a safe haven for Aussie investors and it’s easy to see why. ...Read more
Bonds
Student files lawsuit over government bonds
A 23-year-old student has filed a lawsuit against the Australian government after alleging that it failed to disclose climate change-related risks to investors in the country’s sovereign bonds. ...Read more
Bonds
Bonds in the ‘new normal’ – navigating a recession
Dampening downside risk during a global economic downturn requires active management and informed decisions, writes Justin Tyler. ...Read more
Bonds
Buyers beware of silent risks in bond markets
Investors are being urged not to fall into the trap of buying inferior-quality bonds in a low-yielding environment, despite the promises of higher returns, an industry expert has warned. ...Read more
Bonds
Reasons to invest in government bonds
Many investment experts recommend adding government bonds to an investment portfolio in order to reap its benefits while limiting risks and losses. ...Read more
Bonds
What is credit investing and how does it work?
A well-diversified investment portfolio typically includes credit investments to balance risk and return. Here’s what you need to know about credit investing and how it works. ...Read more
