Build a Secure Bond Ladder Rung by Rung

Physician's Money Digest, May 2006, Volume 13, Issue 5

When putting togetheran investmentportfolio,the idea is toassemble amix of various assets that willwork together to generate thebest possible return. Stocks andbonds are two of the basicbuilding blocks that you'reprobably most familiar with,but beyond simply buying astock or holding a bond,there are many investmentstrategies that canhelp you enhance yourportfolio's performance. If you are abuy-and-hold, fixed-income physicianinvestor,constructing laddered maturitiesportfolios is one method that mayprovide you with some advantages.

Extending the Ladder

Bond laddering refers to the practiceof purchasing different bonds with variousmaturities, so that the dates theycome due are spread out over a numberof years. In addition, as each set matures,the proceeds are reinvested in newbonds with a maturity date farther outthan the longest you currently hold. Inthis way, the ladder is continuouslyextended. When building a ladderedportfolio, the first thingto decide is how tall the ladderwill be. In other words, howlong will the longest maturitybe? Typically investors canexpect to receive the highestyields from bonds with longermaturities. But you need toestablish an end point foryour top rung by determininghow long you wantyour money tied up.

Another important considerationwould be the maturity frequency.You could have bonds comingdue every 6 months, or every 5 years,depending on how you set up yourportfolio. This maturity frequency representsthe space between the rungs ofthe ladder, and it is often calculated as afunction of the longest maturity and theamount to be invested. For example, ifyou decide that 15 years will be thelongest maturity in your portfolio, andyou have $100,000 to invest, you couldbuild a ladder with 10 rungs of $10,000each, spaced 1½ years apart.

Some bonds contain call provisionsthat let the issuer redeem the bondprior to its stated maturity date. Whilethese may offer higher yields than comparablenoncallable bonds, you'll wantto use these sparingly so as not to riskdisrupting the maturity schedule ofyour portfolio.

Sound Portfolio Structure

In structuring laddered portfolios,investors need to ensure the bonds theychoose meet their specific credit qualityneeds. If you're looking for thestrongest credit quality available, municipalor corporate bonds, Treasurysecurities, or debt of government-sponsoredenterprises should be your topconsiderations.

In addition to the factors alreadymentioned, bonds for a laddered portfolioshould be selected based on theirafter-tax returns as well. For those inhigher tax brackets, municipal bondsprovide exemption from federal and,where applicable, state income taxes,making them a good choice for taxableaccounts. If your laddered portfolio ispart of a qualified plan, you shouldconsider investing in taxable bonds tocapitalize on the tax advantages ofthese types of plans.

Because the market is constantlymoving up and down, many investorsjust can't resist the temptation to try totime the market when purchasing fixedincomesecurities. They hold off purchasingbonds in hopes that higheryields—and therefore lower prices—will become available in the near future.What they fail to remember is that bondyields are just as likely to decrease asthey are to increase at any given time.

By creating a laddered maturitiesportfolio, investors can benefit from astrategy where, whenever a bond in theportfolio matures, the proceeds areautomatically used to purchase newbonds. Because it's such a simple strategy,investors remain fully invested atall times and don't need to worryabout trying to time the market.Depending on your current incomeneeds, a bond laddering strategy canbe customized to match your individualcircumstances. It could prove to bean important element in building youroverall investment portfolio.

Joseph F. Lagowski is vice president, investments,

and a financial consultant with AG

Edwards in Hillsborough, NJ. He welcomes

questions or comments at 800-288-0901,

or visit www.agedwards.com. This article

was provided by AG Edwards & Sons, Inc, member SIPC.