What is bond laddering? How to create a bond laddering portfolio for regular income business News & more related News Here

Consider a scenario in which a 3-year tenure AAA-rated bond offering a good interest rate of 8% per annum invests a lump sum in the renewable bond. Akshay’s analysis shows that during these three years, market interest rates will fall, bottom out and then rise again. At the time of redeeming the bonds and reinvesting the proceeds, they expect market interest rates to be at the same level as 8% per annum or higher.

What is bond laddering?

Bond laddering is a process of creating bond portfolios with different maturity dates at fixed time intervals. The time interval between the maturity dates of 2 bonds is fixed, for example, 6 to 12 months. For example, suppose Akshay wants to invest Rs. 10 lakhs spread over 10 years. In this case, Akshay can choose to buy a bond of Rs 10. Rs 1 lakh each with maturity dates ranging from 1 to 10 years. In this case, a bond will mature each year, creating a ladder-like structure.

building a bond ladder

The table above shows how Akshay’s Bond ladder will look like. When the first bond matures in 2027, Akshay can either use the maturity proceeds for his regular expenses or reinvest them. For reinvestment, he can choose a 10-year bond that will mature in 2037. The second bond will mature in 2028. Renewables can use the maturity proceeds to buy a new 10-year bond that will mature in 2038.

Every year, he can follow the same process by reinvesting the maturity proceeds in a new 10-year bond and continuing the bond laddering process.

If Akshay needs money at short intervals, he can choose to invest in a Rs 20 bond. Rs 50,000 each, with maturity dates at an interval of 6 months. Bond laddering provides benefits such as liquidity and regular income, and avoids timing of market interest rates.

1. Liquidity: Bond laddering provides liquidity at regular intervals. One can structure the bond ladder as per one’s liquidity needs. In our previous example, we saw how Akshay can design his bond ladder with a bond maturity every 6 months or 12 months.

The maturity proceeds from the bonds can be used for regular expenses or reinvested in new bonds.

2. Protection against interest-Rate Change: At maturity, a bond investor faces reinvestment risk if market interest rates have fallen. However, in bond laddering, a bond matures every 6 to 12 months. In some cases, if market interest rates have fallen then the maturity proceeds will be reinvested at a lower interest rate. In some cases, if market interest rates have increased then the maturity proceeds will be reinvested at a higher interest rate. This way, over time, interest rate fluctuations are smoothed out as new bonds are purchased regularly every 6 to 12 months. Therefore, while reinvesting, the investor can move out of the interest rate cycle with each new reinvestment.

3. risk mitigation: An investor can choose bonds for investment based on his risk profile. For example, an investor with a conservative risk profile can choose government bonds, PSU bonds, AAA-rated bonds or secured bonds. Similarly, an investor with moderate to aggressive risk profile can choose below-AA-rated corporate bonds, unsecured bonds, etc.

NSC ladder will be established in 5 years. After that, whenever the NSC certificate matures, the investor can buy a new NSC certificate with the maturity proceeds. The central government announces the interest rate for NSC every quarter. The interest rate for a calendar quarter (for example, April 1 to June 30) is announced before the beginning of the quarter. At the time of purchasing an NSC certificate, the interest rate remains fixed till the maturity of that certificate.

1. Notch: Depending on the amount you want to start with, decide the break-up based on the number of bonds you want to buy and their denominations. We saw earlier how Akshay can break the Rs. In 10 bonds of Rs 10 lakh each. Bonds of Rs 1 lakh or Rs 20 each. 50,000 each.

2. Fixed Income Instruments: The next step is to decide which fixed income instruments you want to use for bond laddering. Some of the fixed income instruments that can be considered include Central Government securities, State Development Loans (SDL), PSU and PSB bonds, corporate bonds, bank fixed deposits, NSCs etc. You can also use a combination of these for your laddered investment strategy.

3. Vacancy: Decide the time interval between the maturities of two fixed income instruments. We saw earlier that Akshay can keep a gap of 12 months between the maturities of two bonds. You can keep the difference monthly, quarterly, half-yearly or annually depending on your need.