On Wednesday, Federal Reserve Chair Janet Yellen said that Interest Rates could be raised next month depending on a wide range of factors that can show whether or not the nation’s economy is improving.
In the meantime, investors continue to look for the best ways to spend their money, especially people who are tucking away money for their retirements. While stocks are the most popular investment, especially when it comes to making fast money, if you have patience to watch your nest egg grow, consider Bonds.
For this article, I’ll go over bond ladders. I’ll discuss the details of putting them together as an investment strategy. But of course, as with all strategies, check with your financial advisor about whether this is best for you. Stock investments can be tricky, but bond ladders can be particularly tricky, especially for novice investors.
· What’s in a name?
Yellen’s announcement gave a better, sooner indication idea of when interest rates may rise, but it is clear that there is a lot of uncertainty surrounding the future of interest rates and the outlook for bonds. That’s one reason to consider a bond ladder.
As noted by Charles Schwab, “investors often build bond ladders to help generate predictable cash flow and help reduce some of the volatility resulting from rising or falling interest rates.”
Bond ladder portfolios contain bonds with different maturities bonds and coupon payments. They can be reinvested according to the “rungs” that make up the ladder. For example, bonds that are reinvested in the longest rung of the ladder offer higher yields than those bonds that are reinvested in the shorter rungs.
For example, if you had $50,000 to invest in bonds, you could use the bond ladder like this: Buy five different bonds each with a face value of $10,000. In the bond ladder approach, each bond would have a different maturity. One bond may mature in five years, and another may mature in 10 years, but each bond would represent a different rung on the ladder.
Here are some tips to build your bond ladder
· Dealing with falling interest rates
As you know, when interest rates rise, bond prices fall, and when they fall, bond prices rise. So you may wonder how this could affect a bond ladder. In this case, you wouldn’t make as much income as before with the same amount invested.
A bond ladder gives you a framework in which to balance the reinvestment opportunities of short-term bonds with the potentially higher yields that longer-term bonds typically offer, says Richard Carter, Fidelity vice president of fixed income products and services.
And consider this. By using the bond ladder approach and staggering the maturity dates, you won’t be locked into one particular bond for a long duration. A problem that can arise when you lock yourself into a bond for a long duration you can’t protect yourself from interest rate risk, notes Investopedia.
· Here are some tips to build your bond ladder
Try to include only callable bonds
Avoid the highest-yielding bonds; at any given credit rating
Include high credit bonds; avoid junk bonds
Build your ladder with high-credit-quality bonds