How To Build A Bond Ladder — And The Best Brokers To Help You Do It

A bond ladder is an investment strategy that involves purchasing multiple bonds that mature at different times.

The ladder analogy is an apt visual tool to describe how bond ladders work: Each rung of the ladder represents a bond, with the lowest step occupied by whichever bond is due to mature the soonest. When that happens, money is freed up to spend, invest elsewhere or reinvest in a new bond to extend the ladder upward.

The biggest advantage a bond ladder has over investing in a single bond is that it allows investors to manage shifting market conditions and changing interest rates while maintaining a steady flow of income.

How to build a bond ladder

There are five main steps involved in building a bond ladder.

1. Identify your overall timeframe: Determine the time span you want your bond ladder to cover, starting with when you first need to draw income from your investments and ending with the furthest date out (typically a number of years in the future). This is where you’ll land on the overall length of your ladder (e.g., a five-, seven- or 10-year bond ladder). 
2. Choose how many rungs you want your ladder to have: This starts with your income needs: How frequently will you need access to your money? Every year? Every two years?For example, if you want to draw income from your investments for the next decade, your 10-year ladder could have five rungs of bonds that mature every two years. Want more frequent access to cash? Then you’d compress the time between intervals and purchase 10 bonds with maturity dates staggered annually across that timeframe. 
3. Purchase bonds for each ladder rung: Here you’ll divide your total investment amount by the number of bonds you’re purchasing. So a $50,000, five-year bond ladder with five rungs would require investing $10,000 in each bond, for example. To account for different maturity dates, you’d purchase a mix of short-term and long-term bonds.
4. Sit back and let your money grow: To avoid transaction fees and receive the full benefit of a bond (such as protection from interest rate fluctuations and steady income flow), you’ll want to hold each bond until it matures. Once your ladder is built, your main job is to hold each one for the full term and collect interest payments along the way.
5. Decide whether to spend, reinvest or deploy your money elsewhere: As each bond matures, choose what to do with your principal — reinvest it into a new bond at the top of your ladder, invest the money elsewhere or use the cash to cover more immediate living expenses.

Variety is what makes bond ladders a valuable tactical tool. As with other assets, spreading your investment dollars around (aka, diversification) helps to reduce your exposure to risk and may lead to higher returns. When it comes to diversifying within a bond portfolio, there are a few factors to consider.

• Bond type: U.S. Treasurys, municipal bonds and corporate bonds are the main types investors use to create bond ladders. (See Bankrate’s full rundown of the types of bonds, including international bonds, agency bonds and high-yield (or junk) bonds.)
• Credit quality (aka bond ratings): Higher-rated bonds are generally preferred as they ensure preservation of capital, a more reliable stream of income and predictable value at maturity.
• Maturity dates: A range of maturity dates (months or years from the time you invest) provides exposure to different interest rate environments.
• Interest rates: A combination of the factors above as well as the prevailing interest rate environment determine a bond’s interest rate, or coupon rate.

Best brokers to build a bond ladder

The best broker for bond ladders depends on your budget and where you fall on the do-it-yourself/manage-it-for me spectrum.

Brokers with ladder-building tools and resources

DIY investors can purchase individual bonds through a discount broker or buy direct from the U.S. Treasury at Treasury Direct.

Trading costs and access to ladder-building tools, research and screening tools and low costs are a must since this approach requires a bit of legwork (e.g., selecting multiple bonds for your ladder and rolling your money into a new bond when each matures).

These brokers are standouts in key areas that matter to bond investors: Charles Schwab, Fidelity, Merrill Edge, E-Trade and J.P. Morgan Self-Directed Investing. They charge $0 to trade U.S. Treasurys and low fees on other bonds. Their investing platforms provide free access to bond portfolio building and management resources.

• Bond laddering tools: Schwab’s CD & Treasury Ladder Builder, Fidelity’s Bond Ladder Tool and E-Trade’s Bond Ladder Builder make easy work of structuring a bond portfolio based on your timeline risk preferences.
• Bond screeners: All of these brokers offer basic and advanced screening tools to assist in identifying bonds that align with your investment objectives.
• Bond resources and market commentary: The best brokers for bonds provide a range of resources for investors at every level, including education on the basics of bonds and access to expert commentary and market news,
• Client support: In addition to on-call technical help, these established brokers have dedicated teams of fixed-income specialists to assist customers with every step of the process of building a bond ladder.

Platforms that offer automated bond laddering

At the other end of the spectrum are firms that handle all the logistics for you.

Wealthfront Automated Bond Ladder

Wealthfront earns high marks for taking all the headaches out of building a bond ladder. The robo-advisor’s Automated Bond Ladder handles the buying and reinvesting based on the ladder length (anywhere from three months to six years) you choose.

Ladders are built with a mix of U.S. Treasuries (bills and notes), and customers can turn the automatic reinvesting feature off at any time. Wealthfront charges a 0.15 percent annual advisory fee on bond ladders to handle the heavy lifting. For context, Wealthfront charges a 0.25 percent annual fee for its automated portfolio management service.

The $500 minimum initial deposit requirement ($100 minimum for subsequent deposits) and 0.15 percent annual advisory fee make this an appealing and affordable option for investors looking for a simple way to use the bond ladder strategy.

Public Treasury Account

Public is another option for investors who want a little or a lot of bond ladder management help.

The broker’s Treasury Account lets customers invest in either pre-built or self-built Treasury ladders that are automatically reinvested at maturity or made available for cash withdrawals. Maturities range from three months to 30 years.

You can get started with a Treasury Account at Public for $1,000. The broker’s tiered management fee (0.09 percent to 0.29 percent) applies to different portions of the portfolio based on asset amounts. Smaller accounts pay the higher management fee (0.29 percent on the first $25,000) with additional amounts subject to lower fees (e.g., 0.24 percent applies to the next $75,000-$100,000 and so on).

Brokers that offer fractional bond investing

The high cost of investing directly in bonds — versus buying a bond ETF — can make it difficult for investors with smaller wallets to get started. Minimum investment requirements typically start at $1,000 and can be much higher for corporate and municipal bonds.

Although fractional stock investing has become more widely available via discount brokers, only a few brokers have ventured into fractional bond investing, offering a way to buy a portion of a bond for as little as $100.

Two brokers stand out for their low-dollar entrée into bond investing.

• Webull: The broker currently offers fractional share investing in Treasurys with a minimum initial investment of $100 and plans to expand into a subset of corporate and municipal bonds in the future.
• Public: The menu of fractional bonds at Public includes more than 90 corporate bonds and roughly 100 Treasury bonds available for as little as $100 to start.

Pros and cons of a bond ladder strategy

Building a bond ladder comes with both potential benefits and drawbacks. Often, the balance between these can be influenced by external factors such as market conditions and the individual investor’s financial goals.

Pros

• Risk management: Bond ladders spread the risk of interest rate fluctuations across several bonds with different maturity dates. This reduces the impact of any single change in interest rates on the entire portfolio.
• Predictable income stream: As each bond within the ladder matures, it provides a known amount of income. This can be particularly helpful for those with predictable upcoming expenses or who rely on their investments for regular income. Retirees can even structure a bond ladder to provide monthly income.
• Opportunity for higher returns: As bonds mature, the proceeds can be reinvested into new bonds that may offer higher yields if interest rates have risen, potentially leading to higher returns. Long-term bonds typically offer higher rates than short-term bonds, so maturing bonds can be reinvested at the end of the ladder to take advantage of the higher potential returns.
• Flexibility: With a bond ladder, you have the flexibility to reinvest in different types of bonds as the market changes, allowing you to adapt to new market conditions.

Cons

• Default risk: There’s always the risk that the issuer of a bond could default, which could result in a loss. This risk can be mitigated somewhat through diversification and paying close attention to bond ratings as you build your ladder, but it’s still something to keep in mind.
• Research complexity: Building a bond ladder requires a good deal of research to select the right bonds, determine the appropriate spacing of maturities and monitor the ladder regularly.
• Diversification risk: While a bond ladder can help diversify interest rate risk, it may not provide the same level of diversification as a bond mutual fund or bond ETF, which can spread risk across a larger number of bonds.
• Potentially high trading costs: Buying and selling individual bonds can come with higher trading costs, especially for smaller, retail investors. Individual bonds may also have minimum investment requirements higher than most bond funds.
• Capital gains limitation: Bond laddering typically involves holding bonds until maturity, which can limit the potential for capital gains that could be realized by selling a bond before maturity when its price has increased.

As with any investment strategy, it’s crucial to weigh these factors against your personal financial goals, risk tolerance and investment timeline. For some, the benefits of a bond ladder strategy may outweigh the potential drawbacks, while for others, an alternative approach (e.g., investing in bond funds) could be more suitable.

Bottom line

A bond ladder is a flexible and strategic investment approach that can help you manage changing interest rates while ensuring a steady income. While there are potential drawbacks to consider, consulting with a financial advisor can help you weigh these against your personal situation and determine if a bond ladder is right for you.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.