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Bond Ladders: A Useful Tool for Retirement Income

Key Points
  • Bond ladders can be a useful tool in retirement, helping generate scheduled cash flows that can help to pay expected bills even in an unpredictable market and interest rate environment.

  • Knowing that a certain amount of money can be available when you need it may help you feel more comfortable investing the rest of your portfolio more opportunistically.

  • To build a bond ladder, talk with Schwab fixed income specialist or search for bonds on Schwab.com.

Bond ladders have many uses, including helping to balance the desire for current income with the opportunity to benefit from potentially higher interest rates later on. Bond ladders can help generate predictable cash flow, while managing some of the volatility that results when interest rates rise or fall.

But by “laddering” bond maturities—and thus, the dates on which you’ll receive principal back—you can plan on a set amount of cash being available to you when you need it, subject to default, early call features, or credit quality of the bond you own. This is a useful planning feature of bonds—and bond ladders.

Here are a few things to consider when using bonds in retirement.

What is a bond ladder?

A bond ladder is a bond investment strategy in which you purchase individual bonds with staggered maturities, spreading investments across a particular time horizon and limiting exposure to any single bond or interest rate. The goal of a ladder is to have bonds maturing at set, but staggered, intervals.

Bond ladders can help reduce the guesswork in fixed income investing. Timing interest rate increases is difficult, if not impossible, even when the consensus view is that rates will rise—or fall. A case in point: When interest rates rise, the price of bond investments generally fall, eroding the value of a fixed income portfolio. Yet after the Federal Reserve (Fed) raised short-term interest rates in December, yields on many types of bonds fell instead of rising, surprising some investors. That’s partly because long-term bond yields don’t necessarily move in lockstep with short-term interest rates; longer-maturity bonds tend to respond to other factors, such as expectations for inflation and economic growth.

We think that ladders may make sense even as the market anticipates additional Fed rate hikes. Also, the discipline of a ladder strategy is a bit like dollar cost averaging when buying stocks—it ensures that you invest at regular intervals instead of trying to time the market.

Should I use ladders for income?

Investment income from a bond ladder is helpful, but interest payments on many types of bonds are low, so you’d need a large portfolio, relative to your needs, to live off investment income from your ladder alone.

We suggest a broader definition of “income,” in which you use your entire portfolio, including investment income, cash from maturing bonds or relatively stable investments, and capital gains to fund retirement—or other—spending needs. Ladders can be used to increase stability in your portfolio, because as the bonds in your ladder mature, you should receive a set amount of money at expected intervals, subject to bond credit quality.

What bond maturities should I include in my ladder?

We believe that you should build the short end of your ladder, for money needed soon, with investment grade bonds or certificates of deposit (CDs) with maturities between one to four years. You can choose bonds or CDs with maturities spread out annually, or every three to six months, depending on your needs. CDs, unlike bonds, are generally issued by banks, and typically are backed by FDIC insurance, up to certain limits, unlike individual bonds.

Yields on these short-term bonds will be low, at least in the current interest rate environment. But the yield is less important than stability, predictability, and being able to time when money is available.

Consider adding longer maturities, ranging from five to 10 years, for money needed later. This can add diversification and higher income potential. In our view, you should be cautious adding bonds with maturities much longer than 10 years. Bonds with longer maturities are more sensitive to changing interest rates, and the slightly higher yield for longer-dated bonds may not be worth the risk.

How do I combine a ladder with my long-term portfolio?

Consider using bond ladders to manage the likelihood that a certain amount of money will be in your account when you need it. The knowledge that cash will be there can help you invest the rest of your portfolio more opportunistically—and you’ll generally have an easier time riding out market volatility if you don’t need to sell investments to support spending.

Some investors reinvest the proceeds from a maturing bond into a new bond with a longer maturity, keeping the structure of the ladder in place. You can do this as well, if you don’t need the cash. Or you can act opportunistically, drawing from the long-term portfolio to replenish the ladder when needed.

Ideally, you can tap your portfolio when you periodically rebalance to add bonds to your ladder after short-term bonds mature. That way, you’re not just spending principal, but using your entire portfolio, including capital gains earned over time, to fund spending in retirement. 

Use ladders of bonds and CDs as a planning tool

Use ladders of bonds and CDs as a planning tool

Source: Schwab Center for Financial Research. The example is hypothetical and provided for illustrative purposes only. It is not intended to represent a specific investment product.

What types of bonds make the most sense for my ladder?

Stick with high-quality, investment-grade U.S. Treasury securities, investment-grade U.S. corporate bonds (that is, bonds rated “BBB” or higher by Standard & Poor’s and Fitch Ratings, or “Baa” or higher by Moody’s Investors Service) or U.S. municipal bonds to build your ladder.  The risk of default is lower with higher-rated bonds than with bonds with lower ratings. Consider CDs as well. Use non-callable bonds, if possible, to increase the probability that bonds won’t be called before you need principal returned.

We suggest bond funds or professional management when using higher-yielding or more esoteric fixed income investments, to try to boost diversification or yield

What can I do now?

Buying individual bonds and building a bond ladder may seem daunting, but it doesn’t need to be. A Schwab bond specialist can help build a ladder tailored to your needs—considering the number of bonds, the time between maturities and the appropriate types of bonds for you.

Talk to Us

  • Call a bond specialist at Schwab anytime at 877-908-1072.
  • Talk to a Schwab Financial Consultant at your local branch.
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