laddering


Ladder Strategy

An investment strategy in which one invests in several securities with different maturities. When the first one matures, the yield may or may not be used to buy another security. It is used most often with bonds and certificates of deposit. Laddering protects the investor from interest rate risk by locking in interest rates at once.

Suppose one does not use laddering: one may invest $30,000 in a five-year bond with a 4% coupon. When the bond matures, prevailing interest rates may have dropped to 2%, making it impossible to achieve the same profit reinvesting in the same type of bond. Had this investor used laddering, he/she would have put, say, $10,000 into three bonds: a five-year bond at 4%, a seven-year bond at 5.5%, and a 10-year bond at 6%. That way, if prevailing interest rates drop to 2% in five years, this only affects the reinvestment of one third of the initial $30,000 investment. This practice is also called staggering maturities or liquidity diversification.

laddering

An investment strategy in which bonds or certificates of deposit that have different maturities are assembled for a portfolio. For example, an investor with $50,000 might invest $10,000 in bonds with a two-year maturity, $10,000 in bonds with a four-year maturity, $10,000 in bonds with a six-year maturity, and so forth. Principal from matured bonds or CDs is either spent or reinvested in additional bonds or CDs with longer maturities at the top of the ladder. A laddered portfolio hedges interest rate changes by providing liquidity with short-term securities while at the same time providing a relatively steady source of income with long-term, fixed-income investments. Also called liquidity diversification, staggering maturities.

Laddering.

Laddering is an investment strategy that calls for establishing a pattern of rolling maturity dates for a portfolio of fixed-income investments. Your portfolio might include intermediate-term bonds or certificates of deposit (CDs).

For example, instead of buying one $15,000 CD with a three-year term, you buy three $5,000 CDs maturing one year apart. As each CD comes due, you can reinvest the principal to extend the pattern.

Or you could use the money for a preplanned purchase, have it available to take advantage of a new investment opportunity, or use it to cover unexpected expenses.

You can use laddering to pay for college expenses, with a series of zero coupon bonds coming due over four years, in time to pay tuition each year.

And if you ladder, you can avoid having to liquidate a large bond investment if you need just some of the money or to reinvest your entire principal at a time when interest rates may be low.