Investing can feel daunting, especially for those who are hesitant to risk their hard-earned savings on uncertain ventures. However, not all investment strategies involve high risk. For individuals seeking a reliable and low-risk way to grow their wealth, building a bond ladder offers an effective method to generate a steady stream of income while maintaining financial security. A financial advisor could help you figure out how this fixed-income security could fit into your financial plans.

What Is a Bond Ladder?

A bond ladder is an investment strategy designed to provide a fixed income stream while managing interest rate and reinvestment risks. It involves purchasing a series of bonds with staggered maturity dates, creating a “ladder-like” structure where each rung represents a bond maturing at a different time. As each bond matures, the principal is typically reinvested into a new bond with a longer-term maturity, maintaining the ladder’s structure.

Similar to a CD ladder, a bond ladder is a portfolio of fixed-income securities with different points of maturity. Each bond is a rung on the ladder, and the proceeds can be continually reinvested once the bond reaches maturity.

This approach ensures that the investor has periodic access to cash while benefiting from potentially higher yields on longer-term bonds. By diversifying maturity dates, a bond ladder helps smooth out the impact of interest rate fluctuations and offers a balanced combination of liquidity, income and financial stability.

How to Make a Bond Ladder

Creating a bond ladder is fairly straightforward. A financial advisor can help you build one, or you can follow these three steps to do it yourself:

Determine Your Investment Goals and Time Horizon: Begin by deciding how much money you want to invest and how long you want the ladder to last. Your time horizon will influence the maturity dates of the bonds you choose. For example, if you plan to use the income for retirement in 10 years, your ladder should align with that timeline.
Decide on the Ladder’s Structure: Choose the number of rungs (bonds) in your ladder and the intervals between their maturities. For instance, you might create a five-year ladder with bonds maturing each year, or a ten-year ladder with bonds maturing every two years. A shorter interval between maturities provides more frequent access to cash.
Select the Bonds: Look for high-quality bonds that align with your risk tolerance. Options include government bonds, municipal bonds, or investment-grade corporate bonds. Ensure the bonds have staggered maturity dates to maintain the ladder’s structure. Consider the credit rating and yield to maturity of each bond.
Purchase the Bonds: Allocate your investment amount evenly across the chosen bonds. For instance, if you’re investing $50,000 in a five-year ladder, you might purchase five bonds, each worth $10,000, maturing in one, two, three, four, and five years.
Reinvest Maturing Bonds: As each bond matures, reinvest the principal into a new bond at the ladder’s long end. This maintains the ladder’s structure and allows you to take advantage of prevailing interest rates. For example, when the first-year bond matures, reinvest in a bond with a five-year maturity.
Monitor and Adjust as Needed: Periodically review your bond ladder to ensure it aligns with your financial goals and market conditions. Adjustments may be necessary if your circumstances change or if certain bonds no longer meet your investment criteria.

In addition to these steps, here are three basic bond ladder concepts that you will need to learn before investing:

Rungs: The rungs of the ladder are your bonds. To determine how many bonds you need for your portfolio, divide the total dollar amount you want to invest by the length of time you want the ladder to last. The more rungs you have, the more diversified your portfolio will be and the less risk you take. Keep in mind that bonds are typically sold in minimum denominations of $1,000 or $5,000. The more money you invest, the higher your interest payouts will be.
Spacing: The height between each rung represents the proximity of your bonds’ points of maturity. This can range from every few months to several years. Most experts suggest keeping the spacing roughly equal. Longer ladders tend to produce higher income since bonds with longer maturities tend to offer greater coupon rates. Shorter ladders may reduce the average return of the bond ladder, but they also reduce reinvestment risk and increase liquidity.
Materials: The materials you make your ladder from are the types of bonds you choose to invest in. As with a real ladder, you want to find stable, high-quality bonds. It’s also important to pick bonds that can’t be called away early by the issuer. Moody’s and Standard and Poor’s ratings can help you decide, but it’s important to do your research, too. Municipal bonds may have tax advantages and treasury bonds come with a credit guarantee, but corporate bonds usually have higher yields.

Pros of Using a Bond Ladder

The ladder strategy is meant to help investors manage their cash flow while limiting their risk exposure. It can pay off no matter what current interest rates are. Here are three benefits to keep in mind:

Bond ladders create predictable streams of income: Unlike other investments, bond ladder proceeds are incredibly predictable. You know that you’ll receive your principal upon bond maturation, as well as the amount and date of coupon payments you will earn along the way. That consistency makes it easier to design a budget and prevents you from dipping into your savings unexpectedly or unnecessarily.
Bond ladders smooth the impact of interest rate fluctuations: By staggering points of maturity, you avoid getting locked into a single interest rate for several years. As different bonds mature, you can adjust your investments based on the market. If interest rates have increased, you can reinvest at higher rates. If rates have fallen, you still have some bonds locked in for the longer term at a higher rate. Laddering also offers protection against inflation, which diminishes the value of fixed payment returns.
Bond ladders provide flexibility: Perhaps the biggest benefit of bond ladders for newer or more conservative investors, they provide regular access to assets. Whether you have bonds maturing every month, quarter, or year, you can always decide whether you want to extend the ladder by reinvesting that principal into a new longer-term bond. You could also invest in different vehicles now that the credit and interest rate environment has changed. If you need to use the funds for other expenses, you won’t face any penalty.

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Cons of Bond Ladders

A low-risk, continuously yielding investment sounds good on paper, but bond ladders aren’t without their drawbacks. Here are two disadvantages to consider:

Bond ladders do not eliminate all risk: No investment is 100% guaranteed. A bond’s value is dependent on the credit of the underlying company or institution. They can default. Plus, bonds are subject to being called early, which means the interest payments cease and the principal is returned. In addition to decreasing overall yields, that can impair your ladder schedule and limit reinvestment options. You can minimize these risks by diversifying your portfolio with only highly-rated securities, but some risks will remain.
Bond ladders work best with a large upfront investment: Since laddering requires you to buy several bonds at once, and most bonds are issued in denominations of $1,000, they have a higher point of entry than funds. While it isn’t a rule, investment experts only recommend making a bond ladder if you have at least $100,000 to invest. Otherwise, the ladder will be too short, or the rungs will be too far spread out. If you are only investing in corporate bonds, you may want to purchase even more. Greater diversification will help make up for the higher risk of default.

Bottom Line

Bonds are a relatively low-risk way to build wealth. The ladder strategy helps to maximize their benefits. Since there are multiple bonds with staggered points of maturity, bonds are constantly maturing, producing yields, and freeing their principal for reinvestment or other uses. Of course, bond ladders only work if you hold the bonds until they reach maturity. Selling the bonds early or changing investment strategies exposes you to additional risks and defeats the purpose of the ladder.

Investing Tips for Beginners

A financial advisor can help you determine whether a bond ladder is suitable for your financial situation and also guide you in choosing securities as you design the ladder. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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