Should You Be Building Bond Ladders In This Lower Rate Environment?

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Ladder from above

There was an interesting article by Joseph Lisanti in Financial Planning Magazine entitled, “Should You Be Building Bond Ladders?” which read in part:

As with many strategies, laddering works best for clients with sufficient assets to benefit fully from it. “It is a tried-and-true strategy,” says Morris Armstrong of Armstrong Financial Strategies, an RIA in Danbury, Conn.

But even high-net-worth clients can’t eliminate one of the major drawbacks to laddering now. “For me, it’s preferable in a rising-rate environment,” says Armstrong, noting that if you ladder two-, three- and four-year bonds today, rates are essentially flat. “In the old days, it was better.”

But Armstrong says he still occasionally constructs bond ladders for clients. “I can’t stay in cash at 10 basis points for two years,” he observes. His solution is to use short-term fixed-income funds — because “1% is better than 10 basis points.”

A bond ladder is a series of individual bonds each of which has a different maturity date. By having a bond which matures exactly in the year and month you will need the money for withdrawals, you can ensure that you have the next 5 to 7 years of safe spending. To maintain the bond ladder you can then only be purchasing bonds with a 7 year maturity, thus getting the best intermediate term bond interest rate. The current problem with this technique is that intermediate term bonds don’t pay very much, and they don’t pay any more if you extend the term an extra year or two. Thus maintaining a bond ladder currently means locking in low interest rate for a longer term which is not a great idea.

If you are lamenting the low interest rate environment caused by the Federal Reserve, it is a common problem for asset allocation construction. Our solution involves these considerations among others:

  1. You should put 5-7 years of safe withdrawals in the stability of fixed income. The remainder should be in appreciating equities. For a 65 year old this means 75% in equities and 25% in fixed income.
  2. You want the next 5-7 years of withdrawals to be safe. Be satisfied with a lower return on that portion of your money. It is the current price for stability.
  3. Don’t use high-yielding junk bonds to try to boost returns. If you want greater return, put that allocation on the appreciating equity side.
  4. Put a portion of your fixed income allocation into foreign bonds, including some in emerging market bonds.
  5. You should worry about black swan events in inflation and interest rates as much as you worry about black swan events in the stock market.
  6. The bond portion of your portfolio should be balanced by a smaller allocation to resource stocks, sometimes called hard asset stocks.

Photo by Erik Norvelle used here under Flickr Creative Commons.



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David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. In addition to his financial writing, David is a co-author of The Haunting of Bob Cratchit.