Sheila Padden on Reducing Rate Risk Reduction with Bond Ladders (Financial-Planning.com)

Written by Donald Jay Corn, and excerpted from Financial-Planning.com:

Putting fixed income into clients’ asset allocations can be challenging now, with yields depressed and the threat of rising interest rates that would devalue bonds, but one possible solution is to build a bond ladder.

Other applications of bond ladders have emerged. Some advisers have clients spend the maturing bonds’ proceeds while portfolio assets are liquidated to purchase a replacement rung, at the longest end.

“I use ladders for clients who are in and near retirement,” says Sheila Padden, a CFP and the founder of Padden Financial Planning in Chicago. “I mix [certificates of deposit] and bonds, depending on the yields available.”

Padden’s clients have ladders ranging from five to 15 years.

“At a minimum, the ladder rungs produce enough cash to close the gap on income shortfalls for basic living expenses,” she says. “We also may use ladders for required minimum distributions from retirement accounts.”

The drawback of ladders is concentrated credit risk, Padden says.

“Therefore, I use CDs that are insured by the FDIC and Treasury strips,” she says. “Safety trumps yield in securing cash flows for living expenses.”

Treasury strips are zero-coupon securities derived from Treasury issues.

If the near-term bond or CD is liquidated and spent, where does the next rung come from?

“Hopefully, stocks outperform CDs/bonds, and equities become over weighted. We sell stock mutual funds to buy the next rung of the ladder,” Padden says.

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