DEFINITION of ‘Bond Ladder’
A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of purchasing several smaller bonds with different maturity dates rather than one large bond with a single maturity date is to minimize interest-rate risk and to increase liquidity. In a bond ladder, the bonds’ maturity dates are evenly spaced across several months or several years so that the bonds are maturing and the proceeds are being reinvested at regular intervals. The more liquidity an investor needs, the closer together his bond maturities should be.
INVESTOPEDIA EXPLAINS ‘Bond Ladder’
If an investor had one $20,000 bond that matured in five years and earned 2.5% interest per year, the investor would not have access to that $20,000 for five years. Also, if interest rates increased to 3.5%, he would be stuck earning the lower, 2.5% rate until the bond matured.
On the other hand, if the investor had five bonds worth $4,000 each that were laddered so that one bond matured each year, he only have to wait a few months to start earning a higher interest rate on a portion of his investment if interest rates increased.
At the same time, if interest rates fell from 2.5% to 1.5%, the investor would not be faced with putting $20,000 into a lower-earning investment all at once. Interest rates might go back up by the time the other bonds reached their maturity dates.