It’s never a good time to build a short-term bond ladder, but can you picture how investors who did are faring amid today’s market turmoil?
Just as their laddered bonds are maturing, yields are scraping new lows. What’s more, these investors have been missing out on substantial capital gains.
Generations after this conventional but discredited strategy was introduced, it’s a mystery why it survives.
Bond ladders fail investors
With a short-term bond ladder, investors buy municipal bonds that mature between two and 10 years and reinvest the proceeds at (presumably) higher yields.
The problem, of course, is that yields have declined for about 40 years, robbing these investors of the supposed benefit of their ladder.
To fully appreciate the destructive impact of such a strategy, let’s look at an example of an investor in today’s market, with the bottom rung of their ladder maturing and $200,000 to invest.
According to Bloomberg, the average yield on a AAA 10-year bond is about 1.33% today, while a 30-year bond of comparable quality yields 2.04%.
On a $200,000 investment, the 10-year bond yielding 1.33% produces $2,660.00 in annual income vs. $4,080.00 of annual income produced by the 30-year bond yielding 2.04%. That’s a whopping 53% more tax-free income on just this one purchase.
As longtime clients and friends know, we strongly advocate buying and holding quality, long-term municipal bonds. Investors don’t have to guess if interest rates will change, or when and by how much. Most important, they keep their interest clock ticking.
Of course, the market value of longer-term bonds will be more volatile than shorter-term securities, but for veteran investors, this is irrelevant since they are rarely forced to sell their securities.
As we told Forbes (“Supercharged Munis”) more than a decade ago, short-term ladders simply don’t work.
Long-term bonds pay off
Perhaps some brokers advocate ladders because it gives investors the illusion they’re following a sophisticated strategy. Or maybe it’s because they’re attracted by the repeat business.
Regardless, it’s hard to imagine anyone still attempting to build a bond ladder. But if there is, today’s market serves as a stark reminder of why it’s a bad idea.
