Bond laddering is a simple strategy that is commonly deployed by fixed income investors. A laddered portfolio consists of bonds with varying terms to maturity, often with a consistent period of time between each maturity. By creating such a portfolio, an investor will have bonds maturing periodically, allowing the proceeds to be reinvested into new bonds, held as cash in the account, or invested into some other instrument.
The graphic below illustrates a hypothetical portfolio with bonds maturing each year over a five-year period (2019 through 2023). Each year corresponds to a rung in the bond “ladder.”
In the example above, as the 2019 bonds mature, the investor reinvests the proceeds into new, market-rate bonds maturing in 2024. At the close of 2019, the laddered portfolio now consists of bonds maturing in 2020 through 2024. Depending on the goals of the investor, this process can be repeated indefinitely.
This strategy is designed to address some of the main concerns of fixed income investors.
Interest rate risk. One of the biggest risks of holding fixed-coupon bonds is that interest rates may rise, which lowers the value of any bond with a coupon below the current market rate. However, since bond ladders generally hold a number of bonds with different maturities, investors can use the maturing proceeds to invest in current rate issues, taking advantage of the higher rates.
Concentration risk. Bond ladders by definition hold a number of different issues, and this creates diversification1 within the portfolio. Holding a variety of bonds has the potential to help stabilize investor income streams while lowering the impact of any default.
Liquidity. The value of a bond changes daily, and it is always a possibility that a bond owner may want to sell an issue(s) before maturity. Depending on prevailing interest rates, any given issue could be worth more or less than its purchase price. A BulletShares ETF bond ladder creates a series of maturities designed to return a portion of investor principal at par as each rung matures.
While it is possible to create your own bond ladder, there are certain challenges and disadvantages in doing so as an individual investor. Credit quality of the issuer must be reviewed, researching such characteristics as cash flow and optionality takes time, and individual bonds may not trade as actively as equities (which may result in poor pricing on some issues).
Creating a bond ladder with BulletShares ETFs can help mitigate these potential problems. The securities in the BulletShares ETFs have all been subjected to institutional-level research scrutiny. Trade execution is facilitated by designated market makers, assuring a competitive and transparent price at any given time, and all of these ETFs hold a basket of individual issues, which helps diversify credit risk.
To learn more about accessing defined-maturity corporate bond exposure, talk with your advisor or visit invesco.bulletshares.com.
1 Diversification does not guarantee a profit or eliminate the risk of loss.
2 The funds do not seek any predetermined amount at maturity, and the amount an investor receives may be worth more or less than the original investment. In contrast, when an individual bond matures, an investor typically receives the bond’s par (or face value).
3 Shares are not individually redeemable and owners of the shares may acquire those shares from the fund and tender those shares for redemption to the fund in creation unit aggregations only, typically consisting of 100,000 or 150,000 shares.
4 ETFs disclose their full portfolio holdings daily.
5 Since ordinary brokerage commissions apply for each buy and sell transaction, frequent trading activity may increase the cost of ETFs.
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