What Is a Bond Ladder?

Published on October 28, 2022

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Definition

A bond ladder is a way to produce predictable income by purchasing bonds that mature on a regular basis over a period of time. A bond ladder is also a way to manage the risk of interest rate fluctuations. Bond ladders can be created with individual bonds as well as ETFs and mutual funds.

Key Takeaways

A bond ladder is an investment strategy that produces a predictable stream of income via a portfolio of bonds with different maturities.
Bond ladders can help investors manage credit and interest rate risk.
For the bond-ladder strategy to work as designed, investors must hold bonds to maturity.

How Bond Ladders Work

A bond ladder is a way to produce a predictable income stream while minimizing interest rate risk. The ladder consists of bonds (or bond funds or ETFs) of different maturities. When the ladder is first built, the bonds on the lowest rungs with the earliest maturity dates will generally have the lower yields in the portfolio. The bonds at the highest rungs with the latest maturity dates will generally have the highest yields in the portfolio.

As the bonds on the lowest rung of the ladder mature, you have the choice of either reinvesting in bonds on the highest rung of the ladder or moving your investment out of the ladder altogether. As the bonds are reinvested, the yields may be higher or lower depending on interest rates at the time you reinvest (reinvestment risk). If interest rates are higher, you can reinvest at the higher rate and improve your return. If interest rates are lower, your principal won’t return as much as it might, but you will still have bonds in the upper end of the ladder that are at the higher rates.

Note

Bond ladders also provide protection against fluctuations in bond prices. As interest rates rise, the price of bonds fall. The ladder, however, is designed to hold the bonds to maturity, so the change in the value of the portfolio doesn’t affect the strategy.

The strategy can be especially useful for retirees, Michael Finke, professor of Wealth Management at The American College of Financial Services, told The Balance via email. “The primary advantage of a bond ladder is greater certainty about the dollar value of future payouts. For example, if a retiree has a specific future inflexible annual spending goal, they can lock in this amount by creating a ladder of bonds that mature in future years.”

Example of a Bond Ladder

Suppose at retirement you wanted to create a ladder with $250,000 to mature over a 10-year period.

Invested	Years to Mature	Yield	Annual Income
$50,000	2	2%	$1,000
$50,000	4	3%	$1,500
$50,000	6	3.5%	$1,750
$50,000	8	3.75%	$1,875
$50,000	10	4%	$2,000
Total Annual Income			$8,125

When the first bond matures in two years, it’s reinvested at a 10-year maturity. The rest of the bonds continue to move down the ladder. The bond that originally matured in four years now matures in two years, and so on.

Types of Bond Ladders

Bond ladders can be created using individual bonds, or bond funds and ETFs.

Individual bonds offer flexibility. You can select the length of maturity, or “height of the ladder,” as well as the number of rungs, or timing of maturity. However, managing credit risk, or the risk that the bond issuer will fail to make its coupon payments or return the principal at maturity, can be difficult.

Note

If you choose to create your ladder with corporate bonds, the amount of money you have to invest may limit your ability to diversify the portfolio.

Bond ladders can also be created using bond ETFs that have a maturity feature, such as iShares iBonds from Black Rock, or Invesco Bulletshares. These ETFs have a portfolio of bonds that mature at the same time. At maturity, the proceeds are distributed to the shareholders, which can then be reinvested. Bond ETFs can provide portfolio diversification for low minimum investments. They are also generally more liquid than individual bonds because ETFs are traded on the stock exchanges.

What It Means for Individual Investors

Like all investments, bond ladders have risk. “Bond ladders often have a long duration, meaning that their value could fall significantly if interest rates rise,” Finke said. But fluctuations in market value may not matter if investors stick with the plan and hold bonds to maturity.

Bond ladders are a long-term investment strategy designed for income and capital preservation. If you are approaching retirement, or have other reasons for generating predictable investment income, a bond ladder may make sense for you.

Frequently Asked Questions (FAQs)

How much money do I need to build a bond ladder?

If you are building your ladder with individual corporate bonds, you’ll need to buy enough bonds to diversify the portfolio. Since corporate bonds are usually issued in $1,000 or $5,000 denominations, you would likely need at least $350,000. If you use bond ETFs, you can build a bond ladder with a relatively small amount to invest.

How much income can I expect from a bond ladder?

The amount of income will depend on prevailing interest rates, the type of bonds, and the maturity years in the ladder. Corporate bonds will typically generate higher income, but they also have a higher level of risk. U.S. treasuries are considered to be the safest bonds, but will have lower yields than corporate bonds.

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Sources

The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.

Charles Schwab. “Bond Ladders.”
Fidelity. “How and Why To Build a Bond Ladder.”
BlackRock. “What Are iBonds ETFs?”
Invesco. “BulletShares Fixed Income ETFs.”