With interest rates at levels not seen since the 1960's, investors face
a quandary: Short-term rates are ridiculously low while long term rates
expose you to possible rate rises in the future. We don't know when rates
will rise but it's a fair bet that they won't stay at these low levels
for too long. This does not mean that you should abandon bonds. Bonds
are a good source of steady income and deserve to be a part of every portfolio.
As we get older we relay more on income from our investments while preserving
our principal.
One strategy for gaining yield while
controlling risk is a “Bond Ladder”. A Bond Ladder is simple to build:
You divvy up the money that you want to invest into equal portions and
invest the portions into bonds of increasing maturities. For example,
you can build a portfolio with bonds maturing in two, four, six, ten,
and 15 years. When the two years bonds mature you invest the proceeds
into bonds of longer maturity and repeat the cycle every time a bond comes
due. So if rates rise each time you reinvest you're buying a higher yielding
bond. If rates fall or stay the same then you've locked in a good rate
of return from your longer maturing bonds. The Bond Ladder strategy offers
you a better average yield than short-term investments while giving you
an opportunity to take advantage of better yields if rates rise. Remember
that if a need for cash arises, every few years a portion of your bonds
come due.
Ladders can be built with all types of bonds. For investors
that are in the higher tax brackets municipal bonds offer attractive tax-free
yields, while others can build a ladder portfolio with treasury bonds
issued by the federal government or corporate bonds issued by large corporations.
Investors should always be aware of the call features on the bond and
the risk of default. A seasoned bond advisor that knows bonds well can
help you put together a good bond ladder portfolio.
We can't predict what interest rates might do. However,
most advisors think that creating a ladder portfolio of bonds is the best
strategy to protect you in any environment.
