Bond Ladders: A Primer

The one thing that any bond investor should pay attention to—especially right now—is the fluctuations in fixed-income yields. It can be hard if not impossible to determine when yields will rise and fall, which makes it tough to know when the ideal time is to invest your money. In addition, since many investors typically buy and hold bonds until maturity, choosing the right timing adds another level of complexity and anxiety, given that all your money will be tied up for such a long period of time with one municipality or corporation.

Using an approach like a bond ladder can help minimize those stresses. This approach spreads investment dollars out over time and among various issuers, so that investors aren’t required to chance all their dollars at one moment in hopes of getting their timing and selection just right.

The idea behind a bond ladder is simple: bond investors take the money they want to invest and divide it up equally among a series of fixed income securities that mature at different dates. Think of each maturity date corresponding to a “rung” on the bond ladder.

In practice this means, for example, say an investor—let’s call her Lucy—has $100,000 dollars and five fixed income securities that appeal to her, she’ll invest $20,000 in each of the five securities: two FDIC-insured CDs with six and nine month maturities, two municipal bonds that mature at 12 and 18 months, and a two year corporate bond.

When the first FDIC-insured CD matures, Lucy now has $20,000 to invest. If corporate bond yields have gone up, she may wish to move her money there, or she may keep her current risk profile and find an FDIC-insured CD that will mature between her other holdings.

There are a few ways to do this, but since I work for—and many of our readers invest with—Zions Direct, I can show you how Lucy could set that up through our Bonds for Less and auction platforms.

At auctions.zionsdirect.com, she can simply look at the available FDIC-insured CDs and municipal and corporate bonds and bid on the securities she would like to add to her portfolio. To make sure she is competitive, she’ll want to monitor the auctions and it would also be helpful to take advantage of the previous auction results to see where other auctions closed. She can also take advantage of the “Buy Today” feature on many of the auctions (but not all) to ensure she is awarded a piece of the winning allotment. The securities she wins in the auction are held in her Zions Direct account, and when each matures, she is able to return to the auction to replace that “rung”. There is no trading cost for using the auction platform.

If she wants more options, she can use the Bonds for Less platform to search and purchase among 30,000 bonds based on her investment criteria—whether that is security type, rating, location, etc. If she has any questions, she is able to call me or any other representatives at Zions Direct at 1-800-524-8875 to help navigate the site. Bonds for Less online trades are $10.95 for each transaction—which means, going back to our example, that Lucy would be able to set up the five rungs of her ladder for $54.75 in commission charges.

For investors like Lucy, using a bond ladder makes sense for two reasons: first, as mentioned before, a bond ladder can help diversify her investments by spreading her risk across a range of fixed income securities; and, instead of locking the entirety of her investment into one particular bond at a single rate of return for a fixed period of time, she is able to allocate her money across numerous securities at different rates and different maturities.

Second, because only a part of her investment is maturing at any given time, a bond ladder enables Lucy’s assets to stay more liquid, returning her principal when each bond matures. In addition, because of the potential interest payments from her fixed-income securities, she also receives a steady cash flow. Finally, as yields move up and down, Lucy is able to add another “rung” without needing to time every valley and peak.

One last thought: as with any investment, make sure you understand and are aware of the risks involved with fixed income securities. You should pay careful attention to the quality of the bonds you’re considering and their potential for default. Familiarize yourself with changes in ratings, the historical stability, and the financial information of the issuing organizations. Also, you should stay aware of whether or not the bonds you aim to purchase are callable or not, as that may affect the makeup of your bond ladder. Finally, bonds are usually not traded in as high of volumes or in the same way as stocks. Of course, that is the rationale behind using the bond ladder approach—this method of investing focuses on creating liquidity while holding fixed income securities to maturity instead of trying to generate income through trading.

Zions Direct customer or not, you can go to bondstore.com and sign-up for free (if needed) to review bond ratings, issuing organization, term, yield and other criteria. In addition, there are official sites like EMMA and FINRA’s Market Data Center (Bond Section) that you can review before making your purchasing decision.