DEFINITION of 'Bond Laddering'
A portfolio management strategy and model for investing in fixed income that involves purchasing multiple bonds, each with different maturity dates, in order to achieve the following goals:
- Decrease interest rate risk by holding both short-term and long-term bonds, thereby spreading risk along the interest rate curve. If rates are rising, as one bond matures the funds can be re-invested into higher yield bonds.
- Decrease re-investment risk because as one bond in the ladder matures, the cash is re-invested, but it only represents a portion of the total portfolio. Even if prevailing rates at the time of re-investment are lower than the previous bond was returning, the smaller amount of reinvestment dollars mitigates the risk of investing a lot of cash at a low return.
- Maintain steady cash flows to encourage regular saving for investors looking for an income-producing portfolio.
BREAKING DOWN 'Bond Laddering'
Bond laddering tends to decrease the overall risk of a fixed income portfolio. The one downside is that the potential for outsized returns compared to a relevant index is limited because the investor is holding a diversified portfolio in terms of maturation dates. The type of investor who uses this strategy usually places safety of principal and income above portfolio growth.