Municipal Bond Forum
Laddering if interest rates jump?
Q
Regarding your articles about problems with laddering: have you considered that if interest rate jumps to 10%, your original investment of $500,000 will decline? The principle investment value will be much less than $535,000.
A
James A. Klotz responds:
For “buy and hold” investors, market value is irrelevant. It is the additional interest received that distinguishes the long-term approach from laddering and produces more reinvestable income.
Over the life of long-term bonds they are sometimes worth more than their original cost and sometimes less. In either case the higher cash flow keeps coming. If long- term rates jumped to 10%, the additional income generated by the long-term portfolio would allow for reinvestment at these higher rates.
The laddered portfolio, while sacrificing 25% to 40% of income on a current basis, still only has bonds maturing every two years. When a short-term bond matures, the laddering strategy calls for buying a 10-year bond, which again will probably produce only 50% to 60% of the long rate.
Remember, any period of time that the U.S. economy experienced 10% rates was subsequently followed by a recession, which brought much lower interest rates.
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