Spread Out the Wealth with a Bond Ladder for Income & Liquidity

Saving up for retirement takes a lot of planning, even more so as you near retirement age.

You’ll want to put your money in less volatile investments, but will probably want access to your funds whether it’s to keep the cash or to seek higher returns.

A bond ladder can satisfy both needs.

Allocating Your Investment Funds

To understand how a bond ladder works, imagine each rung represents a year. Let’s take a look at an example to demonstrate how to set up a bond ladder:

Sarah recently received an inheritance of $100,000. She’s planning to retire in five years, so she wants to invest in bonds, but she’s not sure if she’ll need to dip into those funds when she retires. Let’s say she splits her funds into four $25,000 increments. Since she’ll still be working for five years, she puts the first $25,000 into a 5-year bond. Next, she invests the second share into a 7-year bond, the third in a 10-year bond, and the last share in a 12-year bond.

When she retires, the 5-year bond will mature and she can decide whether to keep that cash on hand for a retirement expense, like a winter home in Florida, or whether she would like to reinvest all or part of it to keep that stream of income. She now has two, five, and seven years until the other bonds mature. If she decides to reinvest, she could place the first share into a 10-year bond, and continue to roll over the investments if it makes sense for her, based on her financial situation and the investment environment. She would repeat the process each time she reaches a maturity rung on her ladder.

The saying to not put all your eggs in one basket applies to investing after retirement, as well as before. Imagine if Sarah put the entire $100,000 in a 10-year bond. Think about how your life has changed in the last 10 years. With bond laddering, you have access to part of your investment every few years, and can still take advantage of higher yields on longer-term bonds with part of your investments.

Choose Wisely

There are a couple things to keep in mind for this type of strategy. I recommend investing in highly rated bonds to reduce risk, and avoid callable bonds, which could complicate your laddering strategy if the bond issuer elects to exercise their right to “call” or redeem them prior to maturity. Keep in mind; even though bonds are a relatively reliable form of investing, they still come with some risk. Just ask the people who invested in bonds issued by Puerto Rico before the island ran into financial troubles.

While bond ladders can be a savvy investment tool to generate income while allowing you to access your funds at pre-determined intervals, they are just one of many options available for conservative investors seeking to generate income. Like all investments however, they all have their advantages and disadvantages. Therefore, if you think this type of investment strategy is right for you, contact your financial advisor to discuss your situation.