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Protect your Income, Build a Ladder |
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Protect Your Income, Build a Ladder
Bonds are an excellent way to generate investment income. But in a changing interest rate environment, how can you ensure bond income remains steady and stable?
One of the best ways is to use a strategy known as 'laddering." Bond laddering involves putting together a diversified portfolio of quality bond investments consisting of a variety of maturities. Because bonds of different maturities react differently to interest rate changes and other financial market conditions, a laddered portfolio can smooth out the income ups and downs you might otherwise face.
Bond laddering is always a good idea, but it's even more useful in times of uncertainty. Without a laddered portfolio you'll have to wrestle with the notion of adjusting your portfolio in response to rate changes. And the reality is, nobody knows for sure where rates are headed and when.
Your laddered portfolio should consist of short-term, long-term and intermediate-term bonds. Here are the key features of each:
Short-term bonds. These mature in less than five years. Their primary role is to help protect principal. Market values may not fluctuate as much as other bond maturities, although income levels are volatile.
Long-term bonds. These have maturities of more than 15 years, 'locking in' regular interest payments for a longer period of time. However, they are subject to greater price fluctuations than shorter-term investments.
Intermediate-term bonds. These have maturities of 5 to 15 years. They don't fluctuate in price as much as long term bonds, and provide better income stability than short-term investments.
The objective in laddering is to insulate your portfolio from rate fluctuations. If rates fall, income from most of the bonds in a portfolio is still locked in, so it remains relatively stable. If rate rise, short-term investments will do a better job of holding their value. And because bonds mature periodically, you'll have money to purchase new bonds at a potentially higher rates.
Appropriate bond mixes depend on factors such as market conditions. In today's environment a suitable mix might be 25% to 35% of a bond portfolio in short-term investments and 30% to 40% in both intermediate and long-term bonds.
You can ladder other types of income investments, such as guaranteed investment certificates (GICs). In this case you would construct a portfolio consisting of a series of investments that mature at different times.
For example, let's say that you have $50,000. You would invest $10,000 in one, two, three four and five-year GICs. When the first GIC comes due in a year, you reinvest the proceeds in a five-year certificate, which would give you the highest available current interest rate. When the second comes due in two years, you invest in another five-year GIC, and so on, until all your GICs are five-year terms. You will then have one five-year investment coming due every year. |
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