If your portfolio includes fixed-income investments, such as bonds and certificates of deposit (CDs), adopting an investment strategy that spreads their maturities over several years may help you earn better returns and build a nest egg.
Laddering — staggering the dates that your fixed-income investments are due to mature — allows you to reduce your risk and worry less about rising and falling interest rates.
One of the risks of investing in fixed-income securities can be changing interest rates. Suppose you invest $30,000 in a bond that’s yielding 6 percent annually. But when your bond matures, rates have fallen to 3 percent. If you reinvest at the lower rate, your investment will be earning a lot less. If interest rates go up again soon after your purchase, you’ll still be locked into the lower rate unless you can sell your investment, probably at a loss.
With laddering, you invest in bonds with different maturities. Instead of investing all your money in one bond, you use your $30,000 to buy, say, three bonds that come due at different times. That way, you’ll have bonds maturing every couple of years.
As each bond matures, you reinvest the money. If interest rates go up, you’ll be able to take advantage of the higher rate as soon as the next bond comes due. If rates go down, you’ll still be earning the higher rate on part of your investment.
Laddering works just as well when you invest in CDs. By staggering the maturity dates, you can take advantage of any interest-rate increases that occur. Because you’ll never be far from a CD that’s due to mature, laddering gives you greater liquidity. You’ll be less likely to have to cash in an investment before it matures, which can result in penalties.
Article is adapted from content provided by DTS.
