Within your overall investment strategy,
you’ll discover other, more focused, strategies that work
for a particular asset class. Among the best known are laddering
bonds or
certificates of deposit (CDs)
and reinvesting your earnings.
Instead of investing the entire amount you’ve
allocated to bonds in one issue that matures on a particular date,
you divide your investment across three or four bond issues with
similar ratings but different maturities. The shortest term might
be two years, the next one four years, and the third one six years.
As each bond matures, you reinvest the principal
to maintain the pattern of maturation dates. In this example,
a bond matures every two years, but the intervals might be longer
or shorter.
Why ladder?
Laddering has two big advantages.
If interest rates are down when a bond matures,
and you reinvest in bonds, you’ll have to settle for the
lower interest rate and the smaller income it provides. But, if
you have several bonds with staggered maturity dates, only a portion
of your bond portfolio matures and must be reinvested at one time.
That way you’ve limited the risk of reduced earnings to only
part of your bond portfolio.
A second advantage of laddering is that you
can use one of your maturing bonds to make a different type of
investment, or liquidate a bond to cover an unanticipated expense,
without having to sell off all of your bond holdings. That’s
a great advantage if interest rates have increased and you’d
have to sell your bonds at a
discount,
or less than their face
value.
Gail Dudack,
Managing Director,
Dudack Research Group
Gail Dudack explains how laddering
can help protect you from reinvestment risk.
When a fixed-income
investment such as a CD or bond matures, and you use that
money to make a new, similar investment, there's no guarantee
that the new investment you make will offer a similar rate
of return. In fact, the return could be lower — or
higher — based on what's happening in the economy
at large. That's called reinvestment risk.
You can limit reinvestment risk by laddering, since you'll
only have to reinvest part of your total fixed-income assets
at any one time.
Laddering has two big advantages.
Gail Dudack, 