When to Use Laddered Bonds

US News

"Laddered bonds" is a portfolio strategy involving the purchase of a number of bonds with increasingly longer maturity dates. These portfolios are typically used by investors who have $1 million or more allocated to the fixed-income portion of their portfolio, if you are purchasing municipal bonds. If you are purchasing Treasury bonds or FDIC insured certificates of deposit, a laddered bond portfolio can be suitable for investors with smaller amounts to invest.

Since a laddered bond strategy is suitable for a relatively small portion of investors, the onslaught of articles and blogs taking issue with laddered bonds is somewhat surprising. Even respected financial journalist Jane Bryant Quinn weighed in with a negative view.

Investment advisers who don't offer laddered bond portfolios may have an economic interest in this debate. While they are supposed to be constrained by SEC rules and federal laws which prohibit misstatements or misleading omissions of material facts in their blogs and other forms of advertising, they may still spin the debate to favor whatever strategy they typically offer to their clients.

Without doubt, some concerns about laddered bond portfolios are valid. I would be especially wary about having a broker structure a laddered bond portfolio because of the mark-ups and other costs, which are often hidden. A far better alternative would be bond index funds, which are suitable for many investors. Nevertheless, those who paint all laddered bond portfolios with the same negative brush are doing a disservice to investors.

A blog by Thornburg Investment Management notes the primary goal of a laddered bond portfolio is to capture the return of longer-term bonds with less volatility. According to my colleague Larry Swedroe, additional benefits of an appropriately structured laddered bond portfolio include:

-- Avoiding mutual fund expenses

-- Control over credit and term risk

-- Avoiding the impact of hot fund flows

-- Harvesting losses at the individual security level

-- Maximizing after-tax returns (for taxable accounts)

The key to implementing a laddered bond portfolio is to be sure the adviser structuring the portfolio has the expertise to do so. This process involves buying bonds with minimal credit risk (like Treasury bonds, FDIC-insured CDs, and the highest quality municipal bonds), and using an adviser with access to institutional pricing who does not charge any mark-up and who provides transparent data on performance.

A laddered bond portfolio and a bond index fund are not mutually exclusive strategies. For some investors, a bond index fund is the right option. For others, it will be a laddered bond portfolio. Still others may need both a bond index fund and a laddered bond portfolio. Owning both may facilitate the investment of interest payments which can be moved to the bond index fund until there are sufficient assets to purchase individual bonds that can be added to the bond ladder.

If you believe a laddered bond portfolio might be suitable for you, you would be well advised to consult with an adviser who offers both bond index funds and bond ladders. Otherwise, the advice you receive might not be objective or in your best interest.

Dan Solin is the director of investor advocacy for the BAM Alliance and a wealth adviser with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. His latest book, 7 Steps to Save Your Financial Life Now, was published on Dec. 31, 2012.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information, and content on this blog is for information purposes only and should not be construed as an offer of advisory services.



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