Bond laddering for predictable cash flow
The Sterling ReportSunday, September 12, 2021
BY CHRISTINE RANKINE
A popular investment strategy for an investor seeking a predictable cash flow is bond laddering. Bond laddering is in essence building a portfolio of bonds with staggered maturity dates. For example, the portfolio can consist of bonds maturing in three, five, seven and 10 years.
You can think of each bond's maturity as a different rung on the ladder. A major consideration of implementing this principle is the investor intends to hold the bonds until maturity. At maturity an investor will receive the face value of their bond and be able to reinvest that principal in a new bond at the longer-term end of the ladder or other instruments.
Laddering will lock the investor into a current interest rate where you will not be phased by changes in market conditions. As yields in the market fluctuate a ladder will be beneficial to the investor for various reasons. As one portion of your portfolio matures you may be able to reinvest that principal and take advantage of higher yields in the market which were not available when initially investing.
On the flip side, even if interest rates in the market have fallen you would only be reinvesting a portion of your portfolio at a lower rate and the remainder of the rungs (bonds) in your ladder would still be invested in instruments with higher yields. Different maturity dates also give you the flexibility to monitor market conditions and act accordingly.
Before deciding if laddering is for you, it is always beneficial to speak to your financial advisor but here are a few guidelines to bear in mind:
1. An investor should not overextend themselves to invest in various bonds. While using this method to ensure a regular income stream one must be cognisant of their day to day needs and expenditures. Remember the liquidity of your bond will depend on various factors so you should choose them wisely. You don't want to be in a position where you have an emergency and do not have access to funds.
2. Consider your timeline, having structured your ladder you want to hold the bonds to maturity. If you choose to sell before maturity, ensure you seek proper advice so that you may reinvest at a better yield and not disrupt your ladder or come out experiencing a capital loss.
3. The quality of the bonds in your portfolio is very important. Your best bet is to have high-quality bonds with good credit ratings. As we know there are no risk-free investments, but you would want to put your money where you are most comfortable. Don't forget ratings can change so do your research and remember there are no stupid questions, your advisor is there to guide you.
4. Finally, if you must have callable bonds in your portfolio. Keep a close eye on these. Before purchasing these bonds ask for a schedule of the potential call dates and prices. This will allow you to measure the potential of a capital loss based on purchase price.
Bond laddering may be the investment vehicle that works best for you. However, to maximise this strategy an investor must do their research. Choosing the right bonds for your portfolio should be done based on sound research and with your risk appetite in mind. A properly managed and structured ladder will certainly help you unlock another level in your investing journey.
Christine Rankine is the Manager -Personal Financial Planning at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm
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