Municipal Bond Forum
The right kind of ladder
Q
In an article on laddering, it seems as though you favor buying longer-term bonds, as opposed to an initial purchase of a laddered portfolio. But then, years down the road, while continuing to add yearly, one will essentially have created a ladder, isn’t that right? Or is your article solely to compare a one-time purchase, and not a continually adding strategy? You stated that one investor felt the ladder was to avoid loss of principle, but as I understand it, the purpose of a ladder is to minimize interest rate risk, no?
A
James A. Klotz responds:
You are correct, by consistently investing in longer term bonds you will, in effect, create a portfolio with varied maturity dates.
Our quarrel is with short-term laddered portfolios that sacrifice the lion’s share of available tax-free income.
Regardless of the professed rationale for this flawed strategy, having bonds mature regularly in the interest environment that has prevailed over the past 30 years has clearly been a disaster with regard to dependable income and tax-free cash flow available for reinvestment.
Notwithstanding claims to the contrary, when viewed from a historical vantage point it becomes obvious that the short-term ladder actually increases interest rate risk.
Conversely, buying longer-term bonds which maximize income, provides 40% to 100% more reinvestable cash flow, which helps cushion the effects of any interest rate volatility.
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