The bond ladder: a way to avoid guessing the rate

A bond ladder is a portfolio in which the money is spread across issues with different maturity dates so that the redemptions follow each other at equal intervals. The point of the structure is not a higher yield but removing the question of "where the rate will go". An investor who builds a ladder is not betting on direction: they accept in advance that part of the money will come back in an expensive market and part in a cheap market, and they reinvest the rungs that fall due at the price of money prevailing on the maturity date, not at the price they guessed beforehand. The definition in condensed form is in the glossary: bond ladder.

What exactly a ladder does to interest rate risk

A bondholder faces two different risks, and they point in opposite directions. Rising rates hit the market price of issues already bought — the longer the duration, the harder the hit. Falling rates hit the future: redemption and coupon money has to be placed at a lower return than before. This is reinvestment risk, and the shorter the portfolio, the more it hurts.

A ladder eliminates neither of them — it separates them in time. The near rungs barely react to repricing and regularly return the face value; the far rungs hold a locked-in rate for a long time. While rates are rising, the near money that falls due goes into new long issues at new, higher coupons. While rates are falling, the far end of the portfolio keeps paying on the old terms. The investor gets averaging over the cycle — the same logic as averaging the entry price into equities, only applied to the price of money.

An important caveat: the averaging works only if the ladder is actually maintained. The structure lives on discipline — a redeemed rung is moved to the far end. If the redemption money goes to other purposes, within a few years the ladder turns into a short portfolio with growing reinvestment risk.

How to build it

Step 1. Define the horizon — the period over which the money will not be needed in full. This period sets the length of the ladder, that is, the date of the furthest rung.

Step 2. Choose the interval between redemptions. A frequent interval gives more reinvestment points and smoother averaging, but splits the amount into small purchases, where costs and lot rounding are more noticeable. A wide interval is more economical, but makes the portfolio more sensitive to what the rate happened to be on a particular maturity date.

Step 3. Spread the amount in equal parts across issues with the required dates. It is more convenient to select from the redemption calendar than from the issuer's name: the available issues and their maturities are in the bonds section, and government issues are listed separately, under OFZ.

Step 4. Write down the maintenance rule: what to do with a redemption, what to do with coupons, and under what conditions the ladder is shortened. A rule written down in advance is the only protection against the temptation to "wait for a better rate this time".

What the rungs are made of

Government issues are the natural material for a ladder: the maturities cover a wide range, the issues are liquid, and the credit question is off the table. How this market works and who is present in it is covered separately: the OFZ market.

Corporate issues add a premium for credit risk, and here the ladder requires a second axis of diversification — not only by date, but also by issuer. A rung made up entirely of the paper of a single company turns the maturity date into the date on which that company's solvency is tested. What exactly to look at in the financial statements in order to tell a temporary cash shortage from an inability to pay at all is covered here: company liquidity. Issuers' reporting dates are easy to check against the events calendar.

Issues with amortisation, a put offer or a call option deserve particular attention. All of them break the calculated date: amortisation returns the face value in parts ahead of maturity, while an offer gives the issuer an occasion to buy the paper back at a moment that suits the issuer and does not suit the investor. A ladder built without regard to these terms falls apart at exactly the moment when rates are falling.

How a ladder differs from a "barbell" and a "bullet"

A "barbell" puts the money into the short and the long ends, leaving the middle empty; a "bullet" gathers everything around a single target date. Both structures are an expressed view on the shape of the curve and on where it will change. A ladder expresses no view: an even distribution across maturities is a refusal to forecast. Hence its practical property — it does not require the investor to be right, and therefore does not require a regular rethink of the view on rate policy either.

The price of giving up the forecast is giving up the gain from the forecast. An investor who correctly called the peak in rates and locked in a long coupon with the whole amount will beat the ladder. An investor who called it wrongly will lose to it. The choice of structure is a choice between a willingness to be wrong and a willingness to forgo the gain, and it is closer to a question of risk capacity than to a question of calculations.

Taxes, costs and honest limits

Coupons and redemption income are taxed, and this changes the arithmetic of comparing rungs of different length. The composition of the tax base and the applicable rate are in the legal reference: 13%. An account with tax benefits changes the calculation substantially, but the limits and conditions of such accounts are a separate subject and are not covered in this article.

The costs of a ladder are the costs of maintaining it: the commission on every purchase when a rung is moved, the spread on illiquid issues, and the accrued coupon interest paid when buying in the market. The smaller the rung and the more frequent the interval, the more noticeable this item becomes.

A ladder is not needed where the money is required in full by a known date — that is where a "bullet" works. Nor is it needed where the horizon is shorter than the interval between rungs. And it does not replace the decision on what share of savings goes into debt instruments at all, and what share goes into equities or funds. For current yields, maturities and the parameters of specific issues, see the sections of the site — they are left out of the text deliberately: they change faster than the article does. Terms are explained in the glossary.