A bond ladder staggers individual bond maturity dates so that principal comes due at planned intervals. You can use each maturity to fund a cash need or reinvest at then-current rates. This can spread the timing of interest-rate exposure, but it does not eliminate the risk of price declines, default, inflation, or unfavorable reinvestment rates.
What a bond ladder does—and does not do
A bond ladder is a collection of bonds with staggered maturity dates, not a special kind of bond. For example, an investor might choose bonds that mature in successive years. As each one matures, its principal becomes available for spending or reinvestment. The number of rungs and the length of the ladder should reflect the investor’s cash-flow needs and time horizon; there is no universally suitable schedule. FINRA describes laddering as buying bonds with staggered maturities.
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A ladder distributes when principal is scheduled to come due. It does not guarantee a return or prevent a bond’s market value from changing before maturity. It also cannot lock in today’s interest rates for future reinvestments.
Why bond ladders can help manage interest-rate risk
The SEC’s Investor Bulletin explains that market interest rates and bond prices generally move in opposite directions. When rates rise, existing fixed-rate bonds tend to lose market value. If you sell one before maturity, you may receive less than its face value.
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Longer-maturity bonds generally have greater interest-rate risk than otherwise similar shorter-maturity bonds. Duration is one measure of sensitivity to interest-rate changes: higher duration means greater sensitivity. A ladder places some holdings at shorter maturities, which come due sooner, while other holdings retain their existing terms for longer. That spreads the dates when you face the choice to reinvest or use principal; it does not make every rung equally sensitive to rate changes.
If rates rise
Existing fixed-rate bond prices generally fall. Shorter rungs mature sooner, giving you the option to reinvest their proceeds at rates then available. Longer rungs may keep their existing coupons, but can experience larger interim price declines.
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If rates fall
Longer existing bonds may continue paying coupons that compare favorably with new market rates. But when a rung matures, reinvesting its principal may mean accepting a lower prevailing rate. A callable bond may also be repaid early when rates fall, leaving you to reinvest sooner and potentially at a less attractive rate.
How to build a bond ladder
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Set the cash-flow purpose and time horizon
Identify when you may need principal and how much cash you want to become available in each period. Set the ladder’s first and last maturities around those needs. Money you may need before a bond matures should not be treated as if it were guaranteed to be available at face value on demand.
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Choose an interval that fits your needs
Decide how frequently you want maturities. Equal annual intervals are a simple illustration, not a recommended default. More frequent maturities can provide more regular access to principal and more reinvestment decisions. Less frequent maturities mean fewer decisions, but can leave more of the portfolio in longer-term bonds.
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Choose the bond types and issuers
Possible choices include Treasury, municipal, and corporate bonds. Compare issuer and credit risk, tax treatment, call terms, tradability, and cash-flow terms. Treasury securities are generally viewed as having low default risk, but their market prices can still be affected by interest rates. FINRA’s bond overview covers common bond risks and types.
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Compare price and yield, not just the coupon
A bond may sell above or below face value. Review its maturity date, purchase price, coupon, yield to maturity, credit quality, call provisions, liquidity, and duration or other rate-sensitivity information. A coupon alone does not show the return implied by the price you pay or how much the bond’s market value may move when rates change.
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Choose what happens at maturity
Decide in advance whether each maturity will fund a planned expense or be reinvested at the longer end of the ladder. Reinvestment proceeds will be subject to rates and available securities at that future date. For Treasury marketable securities, TreasuryDirect defines reinvesting as using proceeds from a maturing security to buy another security of the same type; available procedures depend on where the security is held.
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Review whether the ladder still fits
Revisit the maturity schedule alongside your cash needs, issuer credit, call terms, liquidity, and concentration in any one issuer. Changes in your plans or a bond’s circumstances may make the original schedule less suitable.
What to compare before buying a rung
Use the same criteria for each candidate bond so the ladder’s cash flows and risks are visible together.
- Maturity and rung spacing: Does the maturity date line up with a planned cash need or reinvestment point?
- Rate sensitivity: How does its duration or other available sensitivity measure compare with the other rungs?
- Price and yield to maturity: Is the bond priced above or below face value, and what yield is indicated at that price if held to maturity, subject to the issuer’s ability to pay?
- Credit quality and concentration: How strong is the issuer’s ability to pay, and how much exposure would the ladder have to that issuer?
- Call or early-redemption provisions: Can the issuer repay the bond before its stated maturity, and under what terms?
- Liquidity and sale costs: How readily could you sell it, and could a broker markdown or transaction cost reduce proceeds?
- Tax treatment: How might the bond’s interest and any gain or loss be treated in your circumstances?
- Cash-flow fit: Will coupon payments and principal maturity dates fit the timing of your planned spending?
FINRA notes that every bond carries interest-rate risk; its effects are only one part of evaluating a purchase.
Risks a ladder does not remove
- Credit and default risk: An issuer may fail to make interest or principal payments as promised.
- Call risk: An issuer may repay a callable bond early, potentially forcing reinvestment when rates are lower. FINRA’s bond guidance discusses call risk and other bond risks.
- Reinvestment risk: Rates available when principal or coupons are reinvested may be lower than the rates you expected.
- Liquidity and sale-price risk: Selling before maturity may require accepting a price below face value, with transaction costs or a broker markdown further reducing proceeds.
- Inflation risk: Inflation can reduce the purchasing power of fixed payments and principal.
- Opportunity risk: If market rates rise after you buy a fixed-rate bond, its existing coupon may be less attractive than newly available rates.
If you hold a bond to maturity, you are due its face value and interest, subject to the issuer’s payment and default risk. Interim price changes may matter less if you do not need to sell. Holding to maturity does not remove inflation, credit, call, or opportunity risks.
How an individual-bond ladder differs from a bond fund or ETF
A direct ladder consists of separately selected bonds, each with its own maturity date. A bond fund or ETF is a pooled investment; buying fund shares is not the same as owning individual bonds whose principal is scheduled to mature on your chosen dates. If having principal come due at specific intervals is the goal, check what you own and how its cash flows work rather than assuming a fund creates the same maturity schedule. FINRA’s bond information provides background on bonds and bond funds.
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