Bond Ladders diversify your maturity rates over time. The change comes from the timing differences between purchasing large amounts of bonds at once and slowly investing in bonds over time. If you purchase single bonds, you may have a large amount of maturities coming due at once, which opens you to larger amounts of reinvestment risk. To avoid the risk of being forced to move money into lower interest rates than before, structure your bond maturities so you never have substantial amounts of bonds coming due at one time.
As an example, if you had $100,000 worth of bonds, you would place $20,000 in bonds due in one year, the next $20,000 in bonds due in three years, and an additional $20,000 in bonds which mature in five years. You would place your remaining money in bonds that mature in different years thereafter, never using more than $20,000 for each year’s maturity. As a result, you never have a large percentage of your $100,000 coming due at one time. You would never be forced to reinvest most of the money at disappointing interest rates.
When each of your early bonds matures, you would purchase bonds which mature the year after your highest maturity date. All newly purchased bonds add another step onto your bond ladder. If your first year bonds mature in 10 years, your third year, fifth year, and every bond purchase thereafter should also mature after 10 years. The result is steady streams of maturity reinvested at constantly current rates, but never enough to place your entire portfolio in serious reinvestment risk.
Alternatively, you can use bond funds which will automatically bond ladder invest for you. Bond managers are forced to adjust their portfolio whenever investors enter or exit the bond fund. Constant investments and cash payments to exiting investors force bond managers to ladder their funds.
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