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What is a Bond Ladder? And how do they work? - YouTube
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Bob French: Hi, I'm Bob French.
This Week in the retirement
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researcher Academy, I did a
pretty deep dive on bond ladders
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with Jason Dai, who heads up
McLean's investment operations
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group. So I figured I would
double dip and talk a little bit
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about bond ladders and some of
the things that you should be
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considering when you're looking
at them. So let's get into it.
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First off, what exactly is a
bond ladder? Well, it's just a
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series of bonds that pay out
sequentially, and that you hold
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to maturity. Typically, you set
it up so that one bond matures
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every year so that you generate
a constant stream of income, but
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that's completely up to you. The
important point though, is that
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you're going to hold these bonds
to maturity. A bond ladder is a
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reliable income strategy. And
while the bonds might sit in
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your IRA or brokerage account
They are really part of your
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investment portfolio. They may
show up in your statements, but
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they're doing something else.
Because you're going to hold
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these bonds to maturity. So long
as they don't default, they
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actually make the promised
payments, you truly do not care
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what the market does, at least
with regards to the bonds in
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your bond ladder. That default
concern is crucial, though, for
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a bond ladder, one of your bonds
defaulting is truly
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catastrophic. There goes your
income for the year. So you
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really want to make sure that
the bonds that you're using have
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as little default risk as
possible. Again, default risk is
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bad, and you really don't want
it. Now, generally, this means
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US Treasury bonds, I guess
there's technically some risk
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that they'll default, especially
when we start talking about
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bonds that are 30 years. 30
years is a really long time as
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you probably recognize from
planning for your own
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retirement. But the general
consensus is that treasuries are
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the safest thing out there in
the market. And as you might
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imagine, a lot of people use
treasuries to build out their
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bond ladders. There are
certainly other tools out there
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that you can use for your
ladder, corporate bonds, Muni
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bonds, multi year guaranteed
annuities, and a whole bunch of
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other things. But you need to
both have a very good reason and
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be very careful when venturing
away from treasuries. One other
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point to throw out there as well
is that retirees are pretty
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exposed to inflation risk. So
you may want to think about
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using tips or Treasury inflation
protected securities to build
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your ladder. These are well
treasury bonds that are
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inflation protected. They
actually adjust the bonds
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principle along with changes in
the inflation rate. This can
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have some nasty tax
consequences, but they're a
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great hedge against unexpected
inflation. So it'll come down to
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your particular situation. But
how long should your bond letter
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be? That's a big fat. It
depends. Just like a lot of
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questions in financial planning.
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That said, probably the most
common approach is what are
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called Social Security bridges.
These basically well bridge the
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gap between when you retire and
when you start collecting your
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Social Security benefits. And
while they're usually tied up
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with the timing, your Social
Security benefits, they don't
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necessarily need to be tied up
with the amount of your
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benefits. You can do what you
want here. And this is important
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because a social security bridge
or Really just any early
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retirement bond ladder can be a
great way to help manage
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sequence of returns risk. But
what about other types of bond
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ladders, you can use bond
ladders for all sorts of
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different purposes, from
essentially creating your own
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more flexible annuity, to using
them as a time segmentation
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strategy by rolling your bond
ladder. There's a lot of
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flexibility here to customize
based on your particular
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situation and retirement income
approach. Just like always, what
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matters is what fits for you.
But let's take a look at that
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though. Bond ladders are
obviously a source of reliable
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income. But how do they fit into
the broader Risa framework?
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Well, by and large, Bond ladders
will tend to appeal to people
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who have a safety first bet, as
well as preferring to maintain
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some level of optionality in
their retirement income. Plans.
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After all, with a bond ladder if
plans A through H blow up? Well,
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they're just bonds. You can go
out and sell sell them to shift
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to another strategy or just
raise whatever capital you need.
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That said, time segmentation
strategies can start moving over
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to the probability based side of
the fence. So it'll really come
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down to what you're looking to
do with your bond ladder.
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They're just a tool. But I want
to jump back to that point about
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a bond ladders optionality your
flexibility. This is one of
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their big differentiators with
most other sources of reliable
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income. You have complete
control over what's happening,
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or at least as much as any of us
have over financial securities.
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And this comes with all sorts of
trade offs. The benefits are
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obvious. You can design the
exact strategy you want and then
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completely change it five years
later if your situation changes
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or even if you just want to. As
I said before, they're just
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bonds, you can go sell as many
of them as you want, though how
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much you get for them will
depend on the current market
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conditions. On the other hand,
there are costs to that
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flexibility. Let's take an
annuity for example, annuities
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tend to be pretty locked out,
it's usually pretty difficult to
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make changes to them after
you've gotten them set up. And
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this gives them a couple
advantages over a bond letter or
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put differently, they can often
be cheaper than a comparable ish
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bond ladder. The first reason
annuities, especially long term
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annuities or lifetime annuities
are often cheaper is just the
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fact that your money is more
locked up. The insurance company
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can turn around and use that
money in different ways. At
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least hopefully, from the
insurance company's perspective,
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they will have a higher expected
return than investing in your
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personal bond ladder. This is
the exact same thing the banks
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are doing with your savings
accounts. They take your money
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in, and then they do other stuff
to use a technical term with
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that money. They make their
money on the spread there. The
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other big thing to consider are
mortality credits. Basically,
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since insurance companies work
with so many people through the
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magic of diversification called
risk pooling in this context,
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they can well, all the risks
associated with their big
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massive clients. In other words,
they aren't looking at you as an
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individual. They're looking at
you as a member of the group.
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And this means that they can
approach everything in terms of
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statistics and expected values.
What are the big things that are
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usually looking at is life
expectancy
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In a lot of annuities, when you
pass away, either your payments
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stop, or they're reduced based
on whatever your particular
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contract says, if you're looking
at one individual person,
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they're either alive and needing
to be paid or not alive. It's
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binary. And the point where a
random person changes state,
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how's that for speaking,
euphemistically, is unknown. But
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with a group, you can get a
pretty solid sense of what the
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distribution looks like. The
insurance company can't say that
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this person is going to die next
year. But they can say, with a
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reasonable degree of certainty,
that n percent of this group
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will die next year, plus or
minus some other percent. And
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they can build these assumptions
into their pricing. That means
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that provided you aren't one of
the people who Has earlier than
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expected, you can often get a
higher level of income from a
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long term annuity than you would
from a comparable bond ladder.
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But, and this is crucial. This
is only possible because they're
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locking up your money. You can
think of that extra income as
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payment for giving up your
optionality. The whole question
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really comes down to how much
you value that optionality
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within the context of your
reliable income, or at least
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this piece of your reliable
income. Overall, Bond ladders
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are great tools that you can use
to create flexible, reliable
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income and really customized to
your particular situation.
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Whether it's a social security
bridge or a time segmentation
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strategy, or we just want some
reliable income that you can tap
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in in emergency bond ladders can
work with really well, but just
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like anything, there are trade
offs that you need to keep in
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mind. If this was helpful, be
sure to like this video and
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subscribe to our channel so you
can see what we're up to. If you
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have any questions on this or
any other questions that you'd
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like me to address, just drop
them in the comments below. You
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