What do bullets, barbells and ladders have in common? It’s not some new kind of exercise routine. Bullets, barbells and ladders are all common strategies for managing portfolios of individual bonds.
If you’re a bond investor today, you know what a struggle it can be to find decent yields in this low interest rate environment. If you stretch out too far for yield by buying junk bonds or put all of your funds into issues with very long maturities, you may be taking on too much risk.
So what are some common strategies that bond investors can use when they want to get some yield, but also need to manage their interest rate risk and credit risk?
One strategy is known as the bullet. With the bullet strategy, you purchase your bond allocation all in the intermediate term, typically about seven to 10 years out. All of these bonds are going to mature within the same time frame, and if rates are higher, you can reinvest at the higher rates.
With the barbell strategy, you put about 50 percent of your allocation into short term issues, like t-bills, certificates of deposit and short term corporate bonds. If taxes are a consideration you can use any of these strategies with municipal bonds as well. The other 50 percent of your funds will go into long term bonds which may mature in 20 or even 30 years. As the short term notes mature, they are rolled over into new short term issues.
The ladder strategy consists of buying bonds about one year apart for as long as you want, just like the rungs on a stepladder. The length of the ladder depends on the individual’s needs. It could be five years, 10 years or 20 years or more.
The concept is pretty simple. Say you have $100,000 for your individual bond allocation. If you want a five-year ladder, you’d put about $20,000 into five bonds with maturities from one to five years. With a 10-year ladder, you’d place $10,000 into 10 different bonds with maturities from one to 10 years.
And the 20-year ladder? You guessed it; you invest $5,000 into 20 different bonds with maturities of one to 20 years. The rungs of the ladder don’t have to be one year apart, either — you could choose six months, or two years, or any other time frame.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information on his money management service can be found at his blog at www.sellacalloption.com or by calling 775-657-8065. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.
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