There comes a time for many of us when we choose to focus less on our work and more on our family, favorite past-times and, perhaps, even traveling. Most of us know this enjoyable and carefree time as retirement.
As the thought of retirement becomes more realistic, so does the idea of creating a steady stream of income to last us throughout the rest of our years. The goal is to create a financial plan that allows one to fully enjoy the fruits of their labor, without stressing about finances.
Those searching for a steady income when they hit retirement have a few options to choose from. These include CDs, individual bonds, mutual funds, or one of the most popular, known as bond ladders.
Below, we have outlined more information about how bond ladders work, as well as how you can use bond ladders to your advantage when approaching retirement:
What is a bond ladder?
A bond ladder is considered a group of investments that provide a steady income stream and gradual return once they mature, otherwise known as a portfolio of fixed-income securities.
The point is to set each bond up with significantly different maturity dates, therefore setting the retiree up for a steady income throughout the rest of their lifetime. These maturity dates can be spaced out across several years, or even several months, depending on the client’s financial needs.
Why use a bond ladder?
The idea of a bond ladder can seem trivial to those who are tempted to invest in one large bond, or maybe a bond fund, rather than a group of smaller bonds with various maturity dates. However, the point of a bond ladder is to diversify credit risk, virtually eliminate interest-rate risk, and create a reliable staggered source of income.
A bond ladder is useful to those who fear the effect that increasing interest rates can have on their investments. When dealing with a bond ladder, the market value of your bonds are almost irrelevant because you are holding your bonds to maturity and not selling them. The price of your bonds only matters when you buy them, because that affects the level of income you will receive upon maturity.
If the Federal reserve is raising interest rates – so what? If the stock market plummets – who cares? The only things that matter is that the companies you have bought bonds from are financially stable. Using bond ladders therefore, can be a nice way to take some of the instability of the stock market, and even the bond market, out of your portfolio, and help you sleep better at night.
In general, there are three factors to consider with a bond ladder: a) the coupon rate of the bond, b) the credit quality of the bond, and c) the maturity date. You want the highest coupon rate, with the highest quality. The maturity date you want is actually determined by the amount of income the ladder generates, and when you want to disperse income. When setting up a bond ladder you will want at least one bond maturing each year that you want the ladder to exist.
In general, there are three factors to consider with the underlying bonds in the ladder: a) the coupon rate of the bonds, b) the credit quality of the bonds, and c) the maturity dates. When building a bond ladder, it is usually preferable to seek bonds with higher coupon rates and higher credit quality, although investors should be wary of unusually high yields attached to high-quality bonds. Additionally, the maturity dates of the bonds should typically be spaced out according to how often you wish to receive income dispersals. Bond ladders are commonly structured with at least one bond maturing each year.
Typically, bond ladders are used in conjunction with other investment strategies; a robust investment strategy is integral for optimal financial success. While investing in bond ladders with staggered maturity dates can be the first step to cultivating a stream of income when you retire, a financial advisor should be consulted to guide your strategies and overall portfolio, and maintain financial success.
If you are interested in bond ladders as an investment strategy, let the team at Morris Financial Concepts guide in the right direction. Contact us today or explore our services further for more information.
The opinions expressed herein are those of Morris Financial Concepts, Inc. and are subject to change without notice. This material is for informational purposes only and should not be considered investment advice. Morris Financial Concepts, Inc. is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Morris, including our investment strategies, fees, and objectives can be found in our ADV Part 2, which is available upon request. MFC-19-10.