Rodgers & Associates employs a strategy for managing fixed-income investments called “laddering.” Each client has a portion of their portfolio allocated to fixed income. The amount allocated to fixed income is then divided evenly among bonds or CDs that mature at regular intervals.
Some of the advantages of fixed income ladders are more consistent returns, low risk, and ongoing liquidity because at every interval there is a bond maturing. With a “laddered” portfolio, fixed-interest investments come due in staggered intervals, at which time they may be cashed or reinvested. Because investments with shorter maturities generally have lower interest rates (assuming all of the other aspects of the bond are equal), laddering provides our clients with the financial benefits of long-term interest rates, but the flexibility of shorter-term maturities.
If your money is instead invested in bond mutual funds, your withdrawals are at the whim of the market to determine how much per share you get upon a sale. Also, bond funds are more susceptible to interest rate risk. At some point, interest rates will probably go up from the current historic lows, causing bond fund values to decline. The average maturity of our collective individual bond portfolios is 2.61 years as of 7/31/11, lower than many bond mutual funds. Higher average maturity corresponds with higher bond duration, a measure of a bond’s sensitivity to interest rates. For example, a bond with a duration of 7 years would be expected to fall 7% in price for every 1% increase in interest rates. Imagine how big the declines could be if interest rates jump up several percentage points!
So in a ladder, each bond acts like a rung, so that rather than taking one big step – such as investing in a single long-term bond – an investor can take smaller steps toward their long-term savings goals. Furthermore, having stepped maturity dates may provide liquidity options that enable a client to hold a security until its date of maturity. This could protect against early withdrawal penalties or a downturn in market value.