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Education Center

Bond Laddering

One popular way that investors can help to balance risk and return in a bond portfolio is to use a technique called laddering. Building a laddered portfolio means that you buy a collection of bonds with different maturities spread out over your investment time frame. For instance, in a ten-year laddered portfolio, you might purchase bonds that mature in 1, 2, 3, 4, 5, 6, 7, 8, 9, and 10 years. When the first bond matures in a year, you'd reinvest in a bond that matures in ten years, thereby preserving the ladder (and so on for each year). The rationale behind laddering isn't complicated. When you buy bonds with short-term maturities, you have a high degree of stability -- but because these bonds are not very sensitive to changing interest rates, you have to accept a lower yield. When you buy bonds with long-term maturities, you can receive a higher yield, but you must also accept the risk that the prices of the bonds might change. With a laddered portfolio, you would realize greater returns than from holding only short-term bonds, but with lower risk than holding only long-term bonds. By spreading out the maturities of your portfolio, you get protection from interest rate changes. If rates fell by the time you need to reinvest, you'd have to buy a bond with a lower return, but the rest of your portfolio would be generating above-market returns. If rates increased, you might receive a below-market return on your portfolio, but you could start to take care of that the next time one of your laddered bonds matures.