In a laddered portfolio, bonds mature every year. As this occurs, the principal proceeds are reinvested at the longer end of the ladder. This generally occurs at higher interest rates. Because only a small portion of the portfolio matures and is replaced each year, the income stream stays relatively constant. As a result, your portfolio should include bonds purchased in periods of both high and low interest rates.
Laddering short-term and intermediate-term bonds helps you captures most long-term bond returns with less volatility. For example, a 10-year ladder can produce the yield and return of 10-year bonds. As a result, it’s five-year average maturity means lower risk. The strategy also smooths out reinvestment risk since money is being reinvested incrementally throughout a full interest rate cycle. The end result is a portfolio with returns close to those of long-term bonds but with substantially less risk. It really doesn’t matter which way interest rates move. With a laddering strategy, it’s possible to get consistent returns. This gives laddering investors a competitive advantage, knowing any time is a good time to build or buy into a laddered portfolio. It’s the smart way to increase a portfolio’s return while minimizing both market and reinvestment risk.
This high-level overview provides information on building your own hypothetical limited term bond ladder.