Friday, March 3, 2023

Bond Ladder

Bond Ladder

The Bond Ladder has recently emerged as the hottest trade on Wall Street. Laddering bonds is both elegant and efficient; investors parcel out their cash via "steps," or purchases, of certain denomination & maturity bonds which yield a certain annual rate. These "steps" form the proverbial rungs of the Bond Ladder. As rates steadily rise, the investor is locking in that higher rate with each new rung.

This strategy is particularly effective in a rising interest rate environment. With a Bond Ladder, the investor is frequently rolling cash into new bonds at higher rates. So for example, using a $120,000 cash position to build a bond ladder an investor could buy Treasury Bills now yielding over 5% at multiple maturities. In this instance, an investor could buy twelve (12) $10,000 Treasury Bill positions maturing each month for the next year. Every month that $10,000 would come due, and the investor could roll those funds into new, and possibly higher paying, Treasury Bills.
With the Federal Reserve hellbent on breaking the back of rampant inflation in the United States, it seems highly probable. In fact, Greenlight Capital's David Einhorn suggests investors should be "Bearish on stocks and Bullish on inflation." Meaning? He suspects that the Federal Reserve will raise rates higher than the existing consensus of 4.50-4.75%.

With Treasury Bills yielding over 5% now, this should be a concern for investors as selling rates are exceeding predicted rates, ie Einhorn is probably correct assuming the Fed raises again in March. There's an old axiom on Wall Street: "Don't fight the Fed." For those investors looking to preserve a portion of their capital, and earn a "riskfree" rate of return, a Bond Ladder here might make sense. 
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