Why laddered bond portfolios cover all the bases

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In evaluating fixed-income opportunities when interest rates are rising, one option to consider is a laddered bond portfolio.

Indeed, a bond ladder is actually quite helpful when rates are increasing or decreasing, observers say.

“It makes complete sense,” says Mick Heyman, principal at Heyman Investment Counseling in San Diego. “A laddered portfolio means that if we’re in a rising rate environment, you have something due every six months or whatever, so you can take advantage of higher rates.”

And the opposite is also true.

“If there’s a shock to the economy and the next thing you know, the 10-year Treasury yield is at 2%, you don’t want everything in your portfolio to be short maturities,” Heyman says.

So, in the end, “a ladder is the safest way to play it,” he says.

“Given the inability of anyone to predict interest rates, you cover all bases. You don’t have to worry about predicting or being wrong,” Heyman says.

Chris Litchfield, a retired hedge fund manager and a private investor in Greenwich, Connecticut, compares using laddered bond portfolios to investing in stock index funds. It is a way of not having to make major decisions about what part of the market will perform best.

“I like the idea. I do it myself,” Litchfield says.

Observers stress that the ladder should be filled with safe individual bonds, not bond funds because with the former, investors are almost guaranteed to get the bond’s face value back at maturity. But with bond funds, if rates rise, there is no guarantee that the fund’s price will ever rebound to the price at which it was bought.

In addition, “you don’t know what an individual fund manager is doing,” Heyman says.

“There could be a high-yield strategy, a barbell strategy,” he says. “[The manager] could be doing any number of things that will lose value.”

The primary role of bonds is safety, Heyman says. “And for safety of principal, if you get a bond fund, you take that away from yourself.”

Observers note that advisors can tilt a bond ladder to take advantage of the rate environment.

So, at a time like now when rates are rising, “you want to go short maturities and high quality,” Litchfield says.

“I’m holding T-bills with any maturities,” he says. “When I feel a little better, I’ll start to extend out the ladder.”

This story is part of a 30-30 series on evaluating fixed-income opportunities when rates are rising.

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