Bond Ladder

[Budman]

I am currently giving heavy consideration to rolling out of my company's 401K into a rollover IRA with Fidelity and establishing a bond ladder with the cash portion of my portfolio. Inside the 401K, my company offers a cash with interest option which is currently paying 4.3%, consisting of hundreds of AAA treasury and insurance contracts. It is quite safe.

I believe I can better that 4.3% with the ladder. Fidelity's bond offerings are paying 5 - 6% + for AA and above rated corporate bonds. A 1% increase in earnings is large over a 30 year retirement and I do not want to cut myself short. I am concerned about the additional risk involved, but everything I read is that the high credit quality bonds have a very low default rate.

To eliminate interest rate risk, I intend to purchase discounted bonds. To reduce credit risk, I will invest in only AA or higher bonds, have mulitple issuers, and I do not want to go out farther than 5 years and will have staggered maturity dates by year. Does anyone have any experience with a bond ladder?

[socca]

Entire (very thick) books have been written on investing in bonds (also discussing individual bond ownership vs. bond fund ownership). I don't have a recommendation at my fingertips - perhaps you can find something in your library or at amazon.com.

If you decide to create a ladder of bond funds instead of a ladder of individual bonds, consider Vanguard as well as Fidelity. I've had accounts with both companies, and think that VG is a better value. They also seem to have or hire competent bond portfolio managers - I haven't had a disaster yet with them (although there's always a first time ) VG does allow you to search for and buy/sell individual bonds, although I've never used this facility myself.

Good luck!

[friar1610]

I have a bond/CD ladder to cover 5 year's living expenses if something should go bad with my "guaranteed" sources of income. All the bonds are Treasuries. Although I have no problem investing in highly rated corporate bonds through mutual funds, I am not interested in holding individual corporates. The reason is that since I own relatively few bonds, there would not be enough diversification to make me comfortable.

[2B]

Buying discounted bonds doesn't eliminate or reduce interest rate risk. If interest rates rise, your resale value of your bonds decrease. You "eliminate" interest rate risk by holding to maturity when your principle is returned. Any "discount" is included in the quoted interest rate but it's obviously not included in the coupon. Unfortunately, you can't hold bond mutual funds to maturity so interest rate risk is always there with them.

The downside of holding individual bonds is the risk of default. Here the answer is diversification. Don't hold more than about 5% in any one issuers bonds and diversify among different industries. Right now you could get great rates on financial company bonds. Unfortunately, you might be buying the next WaMu.

I've given up the higher yields of corporates in favor of the security of CDs. It's easy to create a CD ladder but it's pretty well limited to about 5 years unless you're willing to buy callable CDs.

There are closed end bond funds that have a diversified portfolio of bonds that they intend to hold to maturity. You could research these but you lose yield to a management fee. They usually sell at a discount to NAV so it might be worthwhile. I haven't looked at these lately so I don't have a current opinion.

[OAG]

Quote:

Originally Posted by 2B I've given up the higher yields of corporates in favor of the security of CDs. It's easy to create a CD ladder but it's pretty well limited to about 5 years unless you're willing to buy callable CDs.

Capital One routinely offers FDIC Insured and not callable 7 and 10 CD's. I have them currently out to 2014. If this situation continues next rung may go out to 2019 current APY 5.4%.

[2B]

Quote:

Originally Posted by OAG Capital One routinely offers FDIC Insured and not callable 7 and 10 CD's. I have them currently out to 2014. If this situation continues next rung may go out to 2019 current APY 5.4%.

They weren't in my ETrade list but there were 7 and 8 year Washita Bank CDs at the less than appealing 4.8%. In the callable arena, Doral Bank (PR) has 6.125% that goes out for 15 years.

[Budman]

Quote:

Originally Posted by 2B Buying discounted bonds doesn't eliminate or reduce interest rate risk. If interest rates rise, your resale value of your bonds decrease. You "eliminate" interest rate risk by holding to maturity when your principle is returned. Any "discount" is included in the quoted interest rate but it's obviously not included in the coupon. Unfortunately, you can't hold bond mutual funds to maturity so interest rate risk is always there with them. The downside of holding individual bonds is the risk of default. Here the answer is diversification. Don't hold more than about 5% in any one issuers bonds and diversify among different industries. Right now you could get great rates on financial company bonds. Unfortunately, you might be buying the next WaMu. I've given up the higher yields of corporates in favor of the security of CDs. It's easy to create a CD ladder but it's pretty well limited to about 5 years unless you're willing to buy callable CDs. There are closed end bond funds that have a diversified portfolio of bonds that they intend to hold to maturity. You could research these but you lose yield to a management fee. They usually sell at a discount to NAV so it might be worthwhile. I haven't looked at these lately so I don't have a current opinion.

Thanks for your comments. Yes, I intend to hold the bonds to maturity in the ladder, making interest rate risk a mute point. But the real problem that you identified is the credit risk of holding an individual bond. It could be the next WaMu! The only way I know to reduce this risk is to invest in high grade corporates, have no more than 5% of the ladder with any one issuer, and to keep the holding period short, eg no more than 5 years. I also intend to set up alerts on issuers.

I think that If I embark on setting up a bond ladder, I will take it slow. It might take me a couple of months to get it set up with the least risk, depending on availability of offerrings. I also am inclined not to just rely on S&P credit ratings. I want to know what the interest rate coverage is, or in other words, does EBITDA cover interest expense by 2x.

[Budman]

Quote:

Originally Posted by 2B They weren't in my ETrade list but there were 7 and 8 year Washita Bank CDs at the less than appealing 4.8%. In the callable arena, Doral Bank (PR) has 6.125% that goes out for 15 years.

I like the Doral Bank rate, but 15 years is too far out for me. I will consider CD's, preferred stocks, corporate notes and other in the ladder.

[Budman]

Quote:

Originally Posted by friar1610 I have a bond/CD ladder to cover 5 year's living expenses if something should go bad with my "guaranteed" sources of income. All the bonds are Treasuries. Although I have no problem investing in highly rated corporate bonds through mutual funds, I am not interested in holding individual corporates. The reason is that since I own relatively few bonds, there would not be enough diversification to make me comfortable.

Have you had any misgivings with your ladder. Any surprises?

[2B]

Quote:

Originally Posted by Budman I like the Doral Bank rate, but 15 years is too far out for me. I will consider CD's, preferred stocks, corporate notes and other in the ladder.

Preferreds usually have very long maturities or are perpetual. They tend to be mostly financials and utilities although there are other industries available. Right now BAC.pr.w and JPM.pr.z are around 8%.

Remember, Enron went from AA to junk in about 2 weeks.

Well punk, do you feel lucky?

[Budman]

Quote:

Originally Posted by 2B Preferreds usually have very long maturities or are perpetual. They tend to be mostly financials and utilities although there are other industries available. Right now BAC.pr.w and JPM.pr.z are around 8%. Remember, Enron went from AA to junk in about 2 weeks. Well punk, do you feel lucky?

Punk? LOL! First time I've been called that in about 50 years. With the Enron example, you just never know. Yes, I think I feel lucky confident. I'll just try to limit exposure.

[ats5g]

I guess you have to decide whether or not the yields on the AAA and AA short term bond yields are compensating you for the higher risk vs. FDIC insured CDs.

In comparing the yields on CD's at Vanguard, Fidelity and bankdeals, to AAA and AA short term corp bond yields, I'm not all that inclined to take much credit risk at all.

Also, any potential increase in return/yield from the AA ST corp bonds may not be worth my time to do all the necessary research. Unless you like going over financial statements and such, I might do something else like cut my neighbors yard, etc. for some cash.

- Alec

[2B]

Quote:

Originally Posted by Budman Punk? LOL! First time I've been called that in about 50 years. With the Enron example, you just never know. Yes, I think I feel lucky confident. I'll just try to limit exposure.

I was quoting Clint Eastwood (Dirty Harry). How many bullets?