How do I set up a 5 year bond ladder?

Hello Fools,

I think I am entering a world I am not familiar with. I have been 100% invested in stocks for the past 20 years…I am thinking of slowing things down and building my “cash” or "bond position.

Let’s say that I have a hypothetical amount of $500k cash in a Fidelity account. This allocated amount would be bonds/cds/cash…

How would one set up a 5 year bond ladder within the brokerage account?

Is there an Bond ETF that would make my life easier?

Can i buy TIPS in a Brokerage account?

Keep the funds in a money market account?

I am trying to do my own research, but there are so many opinions out there about bonds/CD/ladders etc…

Stock i know, Bonds I don’t

2 Likes

Hi @darrellquock,

Presuming this is for your expense cash cushion:

I have always tried to keep this simple.

Our cash cushion is in our passbook savings account. Why?

Only one reason: My DW knows where it is and knows how to transfer from it to checking. She also knows how to transfer from her IRA to savings.

She is not an investor. She does not know CD’s, bonds, stocks, etc.

I have had her do some sales of stock in the past, explained the reasons for the sale, etc but it just does not stick. It has to to with interest in the topic you might say.

Having a bunch of different assets to choose from when she needs cash would just be confusing for her.

One thing I have done to offset this is to make our portfolio a cash generator. If she becomes “the survivor”, she can draw the savings account down to zero. Then she can transfer cash from our Roth IRA’s at any time she wants and she knows how to do that.

No decisions on:

  1. Market conditions
  2. Stock prices
  3. Bond yields
  4. Tax rates
  5. Just, she needs cash and it is there for her.

My income target for the portfolio is 150% of our needs. If some companies reduce their dividends, she is still covered. Right now, it is making over 250% of our cash needs.

Having ladders and lots of different holding options is fine as long as the survivor knows how to handle it.

If the survivor does not know how to manage it, it is an additional obstacle that must be overcome at a time when he/she already has a tremendous load to carry.

My “vote” is to keep it simple whether it is a single bond ETF, or a bunch of laddered CD’s, a money market fund or just a savings account.

If the intent of this cash is for investing, I would leave at least 50% as cash and put the rest in an intermediate-term bond ETF possibly with auto-reinvest on.

Does that help you?

Gene
All holdings and some statistics on my Fool profile page
Profile - gdett2 - Motley Fool Community (Click Expand)

3 Likes

Hi my friend. I can’t give individual investing advice. That said, I’m happy to walk through some of the basics of bond laddering.

First, get a sense for how much money you expect the bond ladder to generate each year. If this is for retirement income, you’ll probably want to add an estimate for inflation on top of the cash flows. For instance, if you want $60,000 per year from the bond ladder and expect a 4% inflation rate, you’ll want your bonds that mature 1 year from now to generate $62,400 at maturity, your bonds that mature 2 years from now to generate $64,896 at maturity, etc.

Next, get a sense for how frequently you want the cash to come in. Is $60,000 once a year sufficient? Do you need to see it as $15,000 a quarter? $5,000 per month?

With those mechanics in hand, the next step is to understand the risk tolerance you’re willing to accept in your bond ladder. My personal risk tolerance is investment grade corporates, with screening to assure diversification among issuers and sense checks to look for obvious cases where a bond is investment grade only because the ratings agencies haven’t had a chance to downgrade it yet.

Then, it becomes a matter of buying the bonds. Perhaps the simplest approach – if you can deal with annual maturities – is Invesco’s BulletShares ETFs, https://www.invesco.com/bulletshares/tools/bond-ladder . They have ETFs consisting of bonds that mature in a given year, depending on the specific ETF.

Alternatively, most brokers will have access to a “bond desk”. You may have to use the broker’s desktop browser interface instead of a mobile app or mobile web browser in order to access it. You can then use that interface to screen for and buy bonds that meet your criteria. E*Trade even has a bond ladder builder where you can screen for multiple maturities at once, to simplify the process. I don’t know if other brokers do as well.

After the initial setup, managing a bond ladder is fairly straightforward. If all goes well, the bonds pay timely interest and principal at maturity. If you want to maintain your bond ladder’s length, you buy new bonds one rung beyond the farthest-out maturity of your longest bond, roughly on the timing of when each rung matures. You would likely use cash from interest, dividends, or selling other assets to do so. If you’re not actively spending the bond principal when it matures, you can even plow that back into the ladder as well.

If things do not go well, you will have to deal with default. Diversification, only buying investment-grade bonds, not counting on the interest for immediate spending purposes, and maintaining a cash emergency fund are key tools I use to help protect against the worst outcomes for any given issuer. It’s not foolproof, but thus far, it seems to be holding up.

E*Trade does include a screener for TIPS. i would presume other brokers with bond desks do as well.

Sure – but then that money is not invested the bond ladder, it’s invested in a money market fund.

A key mindset shift is that with typical bonds, the issuer has a contracted payment schedule and maturity date. The number one question you as an investor need to figure out is “how likely will this issuer be able to keep its commitments throughout the expected life of the bond?”

Unless you’re venturing into the high-risk world of busted convertible bonds or issuers in or on the verge of default (in which case you should probably consider your efforts bond speculating rather than a bond ladder), you’re not looking to hit a home run. Instead, you’re looking for an investment that will give you $X on Y date, likely along with regular interest payments along the way.

Within that framework, bond investing can be simpler than stock investing. Indeed, most bond screener tools will share two numbers for any given bond with fixed coupon payments: “Yield to Maturity” and “Yield to Worst”. “Yield to Maturity” tells you a rough estimate of your anticipated pre-tax ROI if the bond pays exactly as expected between now and its maturity date. “Yield to Worst” tells you a rough estimate of your anticipated pre-tax ROI if the bond pays exactly as expected between now and its next available call date. (A call date is a date when the issuer can buy the bond back before maturity, usually at full face value. Not all bonds are early callable, but some are.)

Once you’re satisfied with your screens, buying the next bond in a bond ladder can be as easy as running your screen, sorting by decreasing “yield to worst”, and then going down the list until you find one that also fits the criteria you can’t easily screen for. (An example: If I already own a bunch of bonds by the same issuer that pops to the top of a list, I’ll skip it. In my mind, the improved diversification is worth more to me than the extra 0.1% or so of annual potential returns, given the larger impact to my portfolio of default should that issuer be unable to pay.)

Regards,
-Chuck

3 Likes

Gene,

I get it. Simple and worry free sometimes is better than always “maximizing” returns.

I have a feeling I will just park my money in few CD’s my bank offers…It may not produce the highest returns, but it easy to manage and a true set it and forget it strategy…

3 Likes

Chuck,

Thanks for your wonderful replies…I have a lot to think about.

Like I replied to Gene, I am probably going to just buy CDs…

I am not really concerned about losing this cash position to inflation…It won’t move the needle if I fall behind in the short term.

I mean I got the sails of the Stock Market compounding in the background…LOL

1 Like

You will find the experts on the bond and fixed income board.

https://discussion.fool.com/c/investing-strategies/bonds-fixed-income-investments/42

Your broker has a selection of bonds to choose from. Usually you want investment grade bonds rated BBB or better. Let the treasury yield curve be your guide. They are priced at a differential from the yield curve with lower rated bonds paying better yields but at higher risk.

For a five year bond ladder, you buy five year bonds every year as one matures. Depending on amounts a diversified portfolio including some higher rated junk bonds becomes possible.

Corporate bonds used to be listed on the stock exchange. Now days not many are. Most are traded over the counter. The ones offered by your broker are usually new issue. You pay no commission when you buy.

Its best to hold bonds to maturity. You can sell them if you need cash, but usually at discounted value. Better to avoid that if you can.

1 Like

It’s certainly your choice, my friend.

While it took a bit of a learning and effort curve to set my bond ladder up, now that it’s in place, it takes roughly 5 minutes per month to manage.

CDs and bonds are two different classes of assets, with different risk profiles and money accessibility tradeoffs.

Still, with $500,000 to put towards it (the amount from your original post in this thread), if you can get an extra 1% or so on your money, that’s potentially an additional $5,000 per year. It’s your call on whether that extra potential income is worth the effort and risk profile.

I fully respect the choice to say “it’s not worth it.” I happen to enjoy the combination of art and science that is portfolio management.

Regards,
-Chuck

2 Likes

Since you mentioned Fidelity, you can also buy your CDs via Fidelity and have them remain in your account. And that has a few advantages over using your bank:

  1. If you buy $500,000 of CDs at your bank, you may only be FDIC insured on $250,000 of them (yes, there are ways around this, but all require a bunch of work).
  2. At Fidelity, you can buy CDs from any bank with no fees. That has two advantages:
    a. You can choose banks that offer higher rates.
    b. You will get full FDIC insurance on all of them if you keep the maximum at any single bank under $250k.
  3. All the holdings appear on a single statement, and a single online login. This further reduces complexity.
  4. Finding CDs (or bonds) on Fidelity is trivially easy. They even have a tool to build a 5-year CD ladder automatically (though I don’t recommend using their tool for your actual ladder, instead just use it to educate yourself about how to create a ladder).

Right now, most of the time I am choosing treasury bills instead of CDs for my ladders. Mainly because they offer slightly higher rates. I consider treasury bills and CDs equally safe, one due to the “full faith and credit” and the other due to FDIC insurance (which would fall back on the “full faith and credit” in the event of a major adverse banking event). I also almost always buy “new issue” CDs and treasury bills, unless I happen to spot a particularly good deal (and those are very rare) and grab it quickly enough.

For small amounts, yes, but …

This is an important point. If you are using $500,000 in fixed income to create a ladder to provide periodic income, then an extra 1% is indeed $5000 a year. And I for one am willing to “work” a few hours a year* finding CDs and treasury bonds at my broker for $5000. If I spend 10 hours a year, that’s like earning $500 an hour! Far more than I ever earned while working. And you can even avoid those hours for the most part by instructing Fidelity to reinvest automatically; Then you don’t have to do anything for subsequent purchases. I have some TreasuryDirect holdings that work that way, those are 8-week T-bills, and they simply reinvest every 8 weeks into a new 8-week T-bill, and the interest is deposited into my bank account.

* I buy treasury bills twice each week, every Tuesday and Thursday. It takes a maximum of a few minutes each time, and has become part of my weekly routine already.

You can see here which treasury securities are available right now -

The one maturing on 01/31/2027 is a 2-year note (the 4th one from the top), and the auction is tomorrow. They have an estimated yield, but you won’t know the real yield until the auction closes. When the auction closes, the Treasury sends out a release with the actual yield. Large institutions submit competitive bids for each security, and the result of all those competitive bids determines the yield. But small fry like us submit non-competitive bids and we simply get the yield that was determined by the competitive bids.

New issue CDs are similar, but don’t have a bidding process so you know the yield up front. Here’s an example of the current new-issue CDs available sorted by yield -


You will notice that in the “call protected” column they all say “no”. I do not recommend buying those kinds of CDs. That’s because when you buy a callable CD from a bank, you are buying the CD, but you are giving them an “option” to call the CD each month (beginning in 3 months or 6 months, etc depending on terms). Meanwhile they only give you a few extra basis points in return for that call option. Let’s say you buy that top one, the 6 year CD at a rate of 4.75%, come April, if rates are lower (and they are already lower), they could simply call the CD, and that turns a 6-year CD into a 3-month CD and then you have to find a new CD in April. Now, sometimes it might be worth giving that option (this one is borderline IMO).

Now here is start of the list of non-callable CDs -


You can see that the rate is much lower at 4.3%, and you can look through the whole list of CDs online at fidelity (click on News & Research → Fixed Income, Bonds, and CDs, then select “New issues” tab, then open Treasury list or CD list to see all this).

4 Likes

The Bond Ratings come from the Bond Ratings firms like Fitch and Moody’s, right ? These are the same firms that lied thru their teeth, without consequence, when rating the risk of MBS in the years leading up to the GFC.

Now, I still have a decent throwing arm, but I would not trust bond ratings as far as I could throw them, lol.

To the OP: I personally am not willing to dig into the bond’s offered by Corporations. I would not trust the ratings put on these bonds by the Ratings Agencies. Sounds like you’re more interested in the return Of your principal than the return ON your principal. I am using Treasuries and Cd’s to bide time until I see if this new Administration has a grip on reality.

3 Likes

That depends on the bank. At our credit union each person on the account is given 250,000 of insurance. So with my wife and I it is 500,000. With my Sister, My Mother, and myself on my Mom’s account it is 750,000. It is automatic.

2 Likes

I think Standard & Poors is well known for their bond ratings.

Yes, some are controversial and may be subjective, but they do take a close look at the issuing companies books and decide if they have resources to repay the debt. Rated BB and below do not have resources to repay. Whatever they spend the borrowed funds on must succeed for you to get your money back at maturity. Top rated bonds are from companies with a long history of paying debts.

Bond ratings are far better than nothing. And bonds by firms listed on the stock exchanges are safer and easier to follow. I’d be very cautious of bonds issued by firms you never heard of. And then there are munibonds issued by local organizations like schools, airports, water and sewer companies.

Caviat emptor. But don’t throw the baby out with the bathwater.