How to replace income with a bond ladder – TheTradersWire

How to replace income with a bond ladder

How to replace income with a bond ladder

The biggest challenge that retirees face at the end of their careers is how to make ends meet financially without a paycheck.

Social Security provides basic income to millions of retirees, but it’s important for those who’ve successfully set aside money in retirement savings to invest well and make their investments work as hard as possible for them.

After retirement, many investors turn away from the stock market toward less volatile fixed-income securities, such as bonds and bank CDs. One strategy that involves using bonds or CDs can help you ensure that you’ll have set amounts of income ready for you at fixed intervals throughout your retirement, while also giving you flexibility if it turns out that you don’t need as much income as you had initially projected. This strategy, known as a bond ladder, is easy to use and can also help you boost how much income you get from your portfolio.

How bond ladders work

The bond ladder strategy involves building up a portfolio of multiple bonds that fit with your investment needs. To set up the initial bond ladder, you can buy a large set of bonds that mature at different times, typically investing equal amounts that match up with your anticipated expenses. Alternatively, you can invest in smaller groups of bonds at regular intervals, gradually building the whole bond portfolio rather than seeking to do so all at once.

An example can make bond laddering easier to understand. Say you have $100,000 in retirement savings in 2018 and anticipate needing to replace $20,000 of income each year over the next five years.

To build a bond ladder, you could invest $20,000 in a bond that matures in 2019, $20,000 in a bond maturing in 2020, and equal $20,000 amounts in bonds maturing in 2021, 2022, and 2023.

Alternatively, you could invest just a quarter of your $100,000 total right now in one- to five-year bonds, and then invest another $25,000 three months from now in five bonds with maturities from one to five years. You’d then repeat the process six months from now and nine months from now to be fully invested.

The advantages of bond ladders

There are two key benefits of bond ladders. First, if you anticipate spending down all of your savings according to a set plan, then the bond ladder ensures that you’ll have the money you’ll need when you need it. Strictly speaking, if you know you’ll need a fixed amount several years from now, you can even invest a bit less than the full amount now, because you can count on the interest that the bonds pay to help you reach your target. It’s usually safer to go ahead and invest the full amount now if you can, because that way, the interest can help offset any erosion in the purchasing power of your money from inflation over the period.

Bond ladders are also beneficial when you don’t expect to spend down every penny of your savings. That’s because when a bond comes due on your bond ladder, you can reinvest whatever money you don’t need right away in a new bond that matures after the last bond in your current portfolio.

For instance, in the example above, when the first one-year bond matures in 2019, you could take any amount remaining and invest it in a new five-year bond that will mature in 2024, a year after the five-year bond you initially purchased matures in 2023. Because longer-term bonds tend to pay higher interest rates, bond laddering can boost the total amount of income you’re able to get in interest payments from your investment portfolio.

The downsides of bond ladders

Despite their advantages, bond ladders aren’t perfect. Traditionally, bonds haven’t had as good returns as the stock market has provided, and so for those who need their money to grow during retirement, bond ladders aren’t the ideal solution for all of your investment capital. In other words, you end up paying for the certainty that bond ladders provide by giving up some potential return on your investment.

More importantly, bond ladders lock you into a set of assumptions about when you’ll need your money, and it can be difficult or costly to get at your money before that if circumstances change. If you use traditional bonds for a bond ladder, then market-price changes can result in a loss of principal if you try to get at your money early. Some people use bank CDs instead of regular bonds in order to eliminate this market risk, but in that case, you can end up paying a penalty for early withdrawal that forfeits the interest that your CD generated over a certain period of time.

Ladder up

Bond ladders can be useful for those seeking to replace set amounts of income at fixed intervals. They won’t produce the same growth that stocks can, but they’ll offer peace of mind that your financial needs will be met while giving you some flexibility in producing as much income as possible from your investments.

Published at Mon, 14 May 2018 17:27:26 +0000

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