As USA Today wrote in June of this year, bonds have not been doing very well in recent months and bond investments “probably won’t age terribly gracefully for the next few years.” Bonds have been struggling because interest rates are low, which may be causing you to question whether any type of investment in bonds is a worthwhile one.
While it is undeniably true that the average government bond funds have fallen in value recently (especially when there are concerns about the Federal Reserve stopping its stimulus program of buying bonds and mortgage backed securities), it is also true that interest rates are not going to remain low forever. One way to protect yourself against rising interest rates and to make bond investments pay off is to consider a bond ladder.
Is a Bond Ladder a Good Investment at this Time?
A bond ladder allocates a portion of your retirement savings to interest-earning investments. The idea is to invest in a series of individual bonds that mature in different years. Each rung of your bond latter consists of a different individual bond that matures at a different year. When the bond with the shortest maturity date matures, you then roll over the money into the bond on your ladder that has the longest maturity date.
A bond ladder is a good way to protect you from rising interest rates, because when your short-term bonds mature you can then invest that money at higher rates. This helps to offset any losses you might experience on longer term bonds. Since interest rates are at record lows now, it seems inevitable that interest rates WILL rise in the future. As such, investing in a bond ladder at this time might be a smart bet to ensure that you are protected and that you profit when rates have their inevitable increase.
However there are downsides to creating a bond ladder in this market as well. Creating a diversified bond ladder using individual bonds is really difficult for small investors and unless you’re using treasuries to create a bond ladder, you need to spread your purchases out over a larger number of different bonds so you minimize the credit risk.
The problem is T-notes have been hitting record lows of late, though, with the 10-year T-note dropping to 1.63 percent on the second of May (the 10-year T-note has had an average yield of 6.6 percent since it first began in 1982). While the rates on treasury bonds are bond to go up eventually, bond fund bear markets usually last for a long period of time. In the 1970’s, for example, treasury securities were actually referred to as “certificates of confiscation” according to USA Today, because investors in treasury securities had been losing value in their principal since the Great Depression.
Forbes suggests getting around this problem by creating a bond ladder using bond funds, rather than individual bonds. This can increase liquidity and give you floating rate exposure, so you can experience the benefits of a bond ladder (including protection from rising interest rates) without being tied into treasury securities.