What is Bond Laddering Strategy for Investment
Bond laddering is a powerful investment strategy especially for investors who depend on their investments for income on a regular basis. This applies to investments in various fixed income instruments such as Certificates of Deposits (CDs), US Treasury Notes, Municipal Bonds, Corporate Bonds, as well as zero-coupon bonds.
The key principle behind the bond laddering strategy is to diverse your investments by the maturity of the bonds. You take the amount you want to invest and distribute it evenly in different Certificates of Deposits and bonds that will matury at regular intervals such as every 1 year.
Let’s take an example to understand this. Let’s say you have $500,000 to invest in fixed income. You divide this into 5 investments of $100,000 each and invest it in different bonds maturing in 1, 2, 3, 4 and 5 years respectively. The following graph shows your investments.
Starting today, every one year an investment of $100,000 will mature and will be available to you for reinvestment. When the first investment matures, you take that money and reinvest it in the bond at the longest end of the ladder. The investment which was two years away is now one year away and the original investment that was 5 years away is now 4 years away. And you have now taken your $100,000 and invested in bonds with maturity 5 years away. The ladder is intact as shown below:
This process of diversifying by maturity and reinvesting will continue year after year as long you don’t change your investment goals.
Advantages of Bond Laddering
Bond laddering offers many advantages for bond investors:
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