Why the Risk-Reduction Benefits of Bond Ladders Have Been Overstated

Proponents of bond ladders argue that they will significantly improve the security of financial plans. Others contend that the risk reduction benefits are merely a mirage. I side with the latter view and will explain why.

There is a lot of literature on bond ladders. Those who have written about the subject range from personal finance columnists to academic economists. Names include Suze Orman, Jane Bryant Quinn, Dirk Cotton, Harold Evensky, Michael Kitces, the Bogleheads, Michael Edesess, Wade Pfau and Moshe Milevsky. Stephen Huxley and J. Brent Burns, who developed the concept of asset dedication, are strong advocates for laddering and have written extensively on the subject. Many investment companies have also produced material on bond ladders.

In addition to these articles and books, online discussions with different points of view are particularly informative. This "Retirement Researcher" blog post from Wade Pfau early this year attracted 86 comments, and this later APViewpoint discussion drew 25 comments.

Types of bond ladders

Based on the literature, it is apparent that there are various structures and uses for bond ladders. All bond ladders are portfolios of individual bonds with maturities chosen to match the timing of future obligations. For example, one could construct a bond ladder to pay for the next seven years of estimated retirement expenses.

Discussions about bond ladders are complicated because they depend on particular structures and uses. I have attempted to clarify things by developing the following classification.

Rolling ladders
                Tactical or non-tactical
Non-rolling ladders
                Fixed term – short or long term

In a rolling ladder, new bonds are purchased for the back end of the ladder as bonds mature at the front end. In a non-tactical rolling ladder, the maturity of the longest bond and the overall ladder structure remain constant. A tactical ladder involves varying the maturity of the longest bond based on investment market conditions. For example, one tactical strategy is to not replenish the back end of the ladder when stocks perform poorly.