A ladder strategy spreads investment between securities with different maturation points to limit exposure to volatility. This approach is commonly used with bonds, although it can also be employed for certificates of deposit and other time deposits. Investors who use a ladder strategy ensure that they can access a range of interest rates as securities mature and they reinvest them. They are also not trapped with large amounts of cash when the market is poor, which can put them in an unfavorable position.
In a simple example, an investor might buy three Treasury bonds, maturing in one, five, and ten years. As each matures, the investor can buy another bond, maintaining the staggered maturation rate. For people planning towards an end goal like retirement or paying for college, purchases can be calculated to make sure money will be available when it is needed.
One advantage of the ladder strategy is that it offers an interest rate spread. Rates on products with different maturity rates tend to vary. People who only buy one type of bond will be limited to that interest rate, while the ladder strategy offers several, ensuring more diversification in the portfolio. In addition, since one investment matures at a time, the investor doesn’t end up with a large amount of cash from simultaneously matured securities.
This means that if a bond matures in a poor market, the investor might choose to sink it into a short term investment, hold onto the cash, or use it for something else, without jeopardizing overall savings and financial planning. When the market is better or another bond matures, the money can be plowed back into a new investment at a higher interest rate. The ladder strategy can also generate returns over time that can be used to buy more investments, slowly growing the portfolio, increasing diversity, and improving the chances of saving enough money to meet future needs.
Taking this approach doesn’t require advanced financial planning skills; prospective investors can look at interest rate quotes on several fixed investments to learn more about the available options and may simply divide their funds equally between three to four options. As they mature, the investor can reassess and climb the next rung in the ladder. It can help to hold some more liquid investments in case of emergency, as the funds tied up in long-term investments may not be readily accessible and this could become a problem.