What is Bond Ladder
A bond ladder is a type of investment strategy that involves constructing a portfolio in which bonds or other fixed income securities mature continuously at equally spaced intervals. As the bonds closet to maturity expiry date, the investment is rolled over to the end. This will help to keep the investor’s position of holding bonds with equally spaced maturities.
This Bond Ladder strategy is used to attain higher average yields or portfolio diversification while reducing liquidity and risk of interest rate.
How Does a Bond Ladder Work?
The bond ladder strategy can be constructed with different fixed income instruments. For example, corporate bonds, certificates of deposits, treasury notes, etc. A single bond ladder may use various securities at same time to meet its purpose.
To create this portfolio strategy an investor must decide how much investment they can do and how much long time then can invest, and how far apart to space the maturities. More liquidity means more closer the maturities to each other.
After taking decision investor will split their investable money in to equal portions and buy fixed income securities that mature at equally spaced intervals. For ex- suppose an investor who has Rs.40,000 to invest and wants the maturities to be 1 year over a 4-year period. They will buy Rs.10,000 worth of fixed income securities one year apart from each other. When the 1-year bonds mature, they will roll the investment over into bonds with a 4-year maturity. At second, the bonds with a 2 -year maturity will expire. This will again roll over into bonds with a 4-year maturity. This is repeated each year until the investor is holding all 4-year maturity bonds in portfolio that expire regularly one year apart.
Guidelines to Bond Ladder
Before building a bond ladder, an investor needs to consider below mention guidelines.
1. Know your limitations
2. Holds bonds until they reach maturity period
3. Use high-quality bonds
4. Avoid high-yielding bonds
5. Thinks about frequency and time
Potentials benefits of bond laddering
• Interest rate risk
• Concentration risk