A bond ladder is a fixed income strategy that involves owning a series of individual bonds with staggered maturity dates over time.1 These maturities are often spaced at regular intervals—such as quarterly or annually—though there is no requirement that they follow a specific schedule.
Below, we’ll examine how a bond ladder works, along with the potential advantages and disadvantages of using this approach to fixed income investing.
How does a bond ladder work?
A bond ladder is a strategy in which an investor holds a series of individual bonds that mature at different points over time. These maturities are often spaced at regular intervals—such as quarterly, annually, or at other intervals—but there is no requirement regarding the specific timing or spacing of maturities within the ladder.
Investors can also “mix and match” the types of fixed income securities used to build a bond ladder. This may include U.S. Treasuries, agency bonds, corporate bonds, or certificates of deposit (CDs). While CDs are not technically bonds, they can fit effectively into a laddered structure and serve a similar purpose in managing cash flow and interest-rate risk.
The bonds within a ladder may be interest-bearing, typically paying interest to the bondholder on a semiannual basis. Alternatively, investors may choose to include zero-coupon bonds, which are purchased at a discount to their face value and do not make periodic interest payments. Instead, the bondholder receives the full face (or par) value at maturity, with the difference between the purchase price and the par value representing the bond’s return. A bond ladder can include any combination of interest-bearing and zero-coupon bonds, depending on the investor’s objectives.
Building a bond ladder
When building a bond ladder, there are several important factors to consider.
One of the primary considerations is the timing of the bonds’ maturities. Investors should decide whether they want bonds to mature at regular intervals—such as every six months or annually—and how long the ladder should extend. Common ladder lengths range from three to five years, though longer time horizons may also be appropriate depending on an investor’s goals.
A bond ladder can be an effective way to create a predictable series of cash flows over a defined period. These cash flows can be used for a variety of purposes, such as funding ongoing expenses, reinvestment, or meeting future financial obligations.
In addition to maturity dates, investors should consider the frequency of interest payments generated by the bonds in the ladder. For example, some ladders may include bonds that pay interest every three or six months, providing regular income while the ladder is in place. This feature can make bond ladders particularly attractive for investors seeking consistent income.
Finally, it is generally best to build a bond ladder with the intention of holding each bond to maturity. While bonds can be sold prior to maturity if circumstances change, holding them to maturity should allow investors to fully benefit from the planned cash flows and can help reduce interest-rate risk and transaction costs.²
Benefits of a bond ladder
A bond ladder can offer a number of potential benefits for investors.
Potentially stable and predictable returns. As long as the various bonds are held to maturity, you generally know what your returns should be. Upon maturity, you will receive the face value of the bond. Over the holding period of the bond, you will have received any interest payments that are issued. Bonds used in forming a bond ladder should be non-callable in order to help ensure they will not be called away prior to maturity. This would leave a gap in the ladder.
Minimizes interest-rate risk. The price of a bond can fluctuate with changes in interest rates. Bond prices generally should move inversely with the direction of interest rates. A bond ladder locks in current rates if the bonds are held to maturity. Interest rates may fluctuate during the holding period, but again, this has no impact on the terminal value of a bond if it is held until maturity.
Cash flow management. Bonds often pay interest on a semi-annual basis. The payment dates are often tied to the maturity date of the bonds. When building a bond ladder, investors can use the maturity dates and the dates of the semi-annual interest payments to structure a predictable cash plan through the bond ladder.
Potential downsides of a bond ladder
Research. Building a bond ladder of individual bonds requires a level of research on the individual bonds to be included. Individual investors may not have the knowledge or the capacity to do the type of thorough research that is required in choosing individual bonds to invest in.
Inflation. The impact of inflation can come into play. Most bonds consist of debt instruments with fixed periodic payments over time. To the extent that these payments are fixed, the value of this income stream can be eroded during periods of high inflation. There are, of course, some bonds that are inflation-protected. These are typically Treasuries.
Lack of diversification. While there are different types of bonds that you can invest in, investing in bonds does not contribute much to overall portfolio diversification. It can pay to include different types of bonds in the construction of the ladder, such as corporate bonds, Treasuries, government agencies, and others. If the ladder is built in a taxable account, including municipal bonds may be appropriate, especially if you are looking for some tax savings.
Using the cash generated
Bond ladders can generate cash flow in a couple of ways. Interest-bearing holdings will generate cash on a periodic basis, often semi-annually. The overall ladder will generate cash from these periodic payments over the course of a year, and also when a component of the bond ladder matures.
The cash flow from the interest payments can be used as the investor sees fit. It can be invested elsewhere, it can be used to cover expenses, or for any other use the investor deems appropriate and necessary.
As for the cash received when a bond in the ladder matures, what is done with the cash will depend on the investor’s circumstances and current market conditions. One option can be to reinvest the amount at the far end of the current bond ladder. This can be a viable option if the investor wants to continue the ladder, and it still serves their purpose for starting it.
Another option could be to invest the proceeds elsewhere or use them to cover a given expense. In some cases, the latter may be part of the reason the bond ladder was put in place to begin with. Additionally, current market conditions might also dictate how the investor deploys the proceeds.
Bond ETFs and mutual funds
Instead of a ladder of individual bonds and perhaps CDs, investors might consider using bond ETFs or mutual funds instead.
Bond ETFs or mutual funds often hold certain types of bonds with maturities over varying lengths of time. There are ETFs and funds holding short-term, intermediate-term, and long-term bonds. Additionally, there are ETFs and funds that might hold Treasuries, corporate bonds, munis, and others.
While not the same as a ladder of individual bonds, by assembling several different bond ETFs or mutual funds, you can create a diversified portfolio of bond holdings in terms of maturities and other characteristics.
In recent years, a number of ETFs that emulate a bond ladder strategy have come into the market as well.3
Planning is key
Whether building a bond ladder or using a series of bond ETFs and mutual funds, planning in terms of building the bond portion of your portfolio is key. Look at diversifying the types of bonds and the maturities of these bonds. This can help in a number of ways, including providing some protection against changing interest rates.
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