Traditional Individual Bond Ladders vs. Fixed Income ETFs
A popular strategy used to manage interest rate risk and help ensure consistent cash flow is to create a "laddered" portfolio of individual bonds maturing at different times. Laddering requires continual management as bonds at the shorter end of the ladder reach maturity and the cash is reinvested in new bonds in order to maintain the same overall portfolio duration. In a simple short bond ladder, an investor could purchase 5 individual bonds with 1, 2, 3, 4, and 5 year maturities—when the year 1 bond matures the investor would then purchase a new 5 year bond.
Another way to achieve a similar objective would be to use a longer term fixed income ETFs. For example, the underlying holdings of a 10 year Treasury ETF will continually adjust to ensure consistent exposure to the 10-year part of the curve, while helping to provide a cash flow via monthly distributions, without having to construct a 10 year individual bond ladder.
FAQs
- Q. How does laddering work? Do I need to ladder my fixed income ETFs?
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A. To attempt to manage the risk associated with rolling over maturing bonds all at once, some investors use a "bond ladder" approach. In a bond ladder, investors stagger a portfolio of bonds across different maturities, each of which occupies a rung on a ladder: 1-year maturities on one rung, 3-year maturities on another, and so on.
But because fixed income ETFs have a constant duration, investors do not have to continually buy and sell bonds as time passes to keep the portfolio's duration profile intact the way they do with a bond ladder.
