How Effective Are Bond Ladders?

By Monster Ztudio @ Adobe Stock

I don’t want to bore you with the details of academic studies, but it turns out that bond ladders work. Don’t take my word for it, Derek Horstmeyer, professor of finance at Costello College of Business, George Mason University, discusses his latest research in The Wall Street Journal, writing:

As the Federal Reserve has signaled it will begin to cut interest rates this year, risk-averse investors have been turning to one bond strategy that works well when short-term rates are lower than long term: bond laddering.

Bond laddering is an investing technique that involves buying Treasury bonds of different maturities and then rolling over matured bonds into new bonds that mature later—mitigating the interest-rate risk of reinvesting all at once and providing a steady stream of income as time progresses.

For instance, an investor with $1,000 can put $200 each into bonds maturing in each year over a five-year span—$200 in a bond maturing in one year; $200 in a bond maturing in two years; and so on. As the bonds mature, the investor can take this money—the principal plus accrued interest—and put it in a new bond maturing in five years, extending the ladder to six years from the original date.

But does the strategy work?

To examine this, my research assistants (Katuta Kapinka and Lydia Samuel) and I ran different bond-laddering models. For simplicity, we focused on the scenario detailed above, where the investment starts out spread evenly across one-year through five-year maturity bonds. Then as they mature, the funds are reinvested into new five-year bonds over a 10-year period.

For comparison, we looked at a short-term portfolio (one-year bonds reinvested each year) and a long-term portfolio (seven-year bonds reinvested each year). And we looked at three interest-rate environments—flat rates, rising rates (interest rates increasing 0.5 percentage point) each year from 5% to 10% at the end of the 10-year period, and decreasing rates (interest rates declining 0.5 percentage point) each year from 5% to 0% at the end of the period).

The verdict: The bond-laddering portfolio provides more-stable returns over various interest-rate environments. For instance, if you go with the short-term portfolio option you may secure 7.5% a year if rates go up, or you could wind up with 2.5% a year if rates decrease. But if you go with the bond-laddering portfolio, you can earn 6.3% a year if rates go up, or 3.7% if rates go down.

Action Line: Let Your Survival Guy clean up your bond clutter by emailing me here.

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E.J. Smith - Your Survival Guy

E.J. Smith is Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. His focus at all times is on preparing clients and readers for “Times Like These.” E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH. His first drum set was a 5-piece Slingerland with Zildjians. He grew-up worshiping Neil Peart (RIP) of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West (RIP JB) and Paris. Please get in touch with E.J. at ejsmith@yoursurvivalguy.com To sign up for my free monthly Survive & Thrive letter, click here.

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