Are you looking to create a steady stream of income during your retirement? If so, building a bond ladder might be for you. You can build a simple bond ladder by purchasing government, municipal, corporate bonds or certificates of deposits (CDs) over a consistent period of time (example 5 years). You might be one of those nervous about purchasing long term bonds in this low interest rate environment. If you are one of these people you would not be alone. One way to combat the fears of buying longer term bonds in a low interest atmosphere is to create a bond ladder.
Let me give you an example. Instead of buying a single bond worth $100,000, you would purchase 5 bonds worth $20,000 each.
- One of the bonds would mature in 1 year
- Next bond after 2 years
- Third bond after 3 years
- and so on all the way up to 5 years.
This would in effect create 5 rungs in your bond ladder. When the first bond matures you would simply purchase a new bond that matures in 5 years.
One of the benefits of creating a bond ladder is protection against rising interest rates. If interest rates rise you would simply purchase a new bond at the new rate within a year. There is also a benefit with this approach in a milieu where interest rates are going down, since you have already locked into bonds at higher rates.
As with most things in life and investing, this does not come as a free lunch. There are downsides to a bond ladder. One of the largest is the bond insurer going into default. As was witnessed in the big credit crisis of 2008, even if bonds are rated highly there might still be underlying problems with the issuer. Another risk with bond ladders is the bond debt might be paid back early (the bond was called). In this case you do not get all the interest you thought you would.
When it comes to implementing a bond ladder there are several things you should consider. One is you want to make sure you are building a diverse set of bonds in your portfolio. If you are not sure you are getting enough diversity into your bond ladder, you can consider using target date bond ETFs (Exchange Traded Funds) in your ladder. These are ETFs where the bonds all mature in a specific year. Another implementation issue with building a bond ladder is in common to purchasing bonds in general. With bonds there is not a large clearing house the way there is done for stocks. With stocks you have the NYSE, NASDAQ and etc. as a location to go and get the best trading price for a stock. With bonds they are held at the individual brokerage houses. With this being the case, your brokerage house might not have the best price on a bond. A good way to think of this is like purchasing a new car verse a used car. In this example the new car would be a stock and a used car would be a bond. When you buy a new car you know what the MSRP is for the vehicle. Now you have a target price to pay for any new car you want to buy no matter which dealership you make your purchase. But if you wanted to buy a used car, you would go to the lot and see what was available and see the prices at just that lot. There could be another vehicle, same model, same condition and mileage at another lot across town. Unfortunately, unless you went to this other lot you would not know this. A way to combat this situation is to shop around or go to someone who can get access to a large array of bonds across brokerages.
As you can see building and maintaining a bond ladder takes some time to do, but can reward you with a steady income stream of funds during retirement. If you still would like the benefits of a bond ladder, but do not have the time to devote to it, consider seeking professional help. I am sure there is a financial service professional in your area that is familiar with bond ladders and would be willing to assist you in creating a bond ladder designed around your needs. Are you ready to step up to a bond ladder?
Author
Isaac is a Fee-Only (no products sold) Certified Financial Planner® Practitioner. Isaac founded Stalwart Financial Planning with offices in Fayetteville NC and Durham NC. Isaac provides comprehensive planning and investment management services to individuals from all walks of life. Isaac can be reached by phone at 910-867-8464, or by email (iallen@StalwartPlanning.com). Visit him at Stawart Financial Planning www.StalwartPlanning.com.