What is a Laddered Portfolio?
Laddered Portfolios can be made out of any group individual securities that have a fixed maturity. The intent is to remove interest rate risk by holding the securities to maturity thus eliminating price fluctuations that can be caused by changing interest rates. Other investment risks such default of the issuer or currency risk still remain. The risk of reinvesting the funds received at maturity at a lower rate also remains.
Typical Securities Often Used in Laddered Portfolios
Corporate Bonds – Generally have higher yields because of the perceived higher risk of the corporate issuer. Interest income is fully taxable at the Federal and State levels.
Municipal Bonds – Issued by State and Local issuing authorities. Yields are determined by the relative risk of the issuing authority. These bonds are exempt from Federal Tax and can be exempt from State tax if the taxpayer is a resident of that state.
U.S. Treasuries — Generally considered as the lowest risk security by the investment community. Interest income is taxable at the Federal level but tax exempt at the State level.
Certificates of Deposit (Fixed Rate) – Usually issued by Banks and Federal Deposit Institutions. These are principal protected by FDIC insurance up to certain amounts. Interest income is fully taxable.
Certificates of Deposit (Market-Linked) – These CDs are issued by Financial Institutions with access to the Stock Market. The yield is tied to stock market performance over a certain period instead of a fixed rate. Interest income can be more or less than a fixed rate CD depending on market performance. They are principal-protected, the minimum return is zero, and FDIC insured.
Mix and Match – It is also possible to put together several of these different types of securities in complimentary Ladders to take advantage of each of their unique characteristics. An example would be a mix of Fixed Rate CDs and Market-Linked CDs for an investor that wants to maintain some exposure to a rising market environment.
Risk Avoidance – Investors often use Laddered Portfolios to “park” cash if they do not choose to participate in the Stock or Bond Market but still would like to generate some interest income above Money Market rates.
Maturity Matching – Laddered Portfolios can be tailored to accrue interest and then generate free cash at very specific intervals. The securities that make up the Laddered Portfolio are bought on the large secondary market where precise maturity dates can be chosen.
Liquidity Risk – The securities in a Laddered Portfolio usually can be sold or redeemed before maturity but this may expose the Investor to market price risk or redemption penalties. The key to this strategy working successfully is to hold the securities to maturity to avoid these risks.
Tax Equivalent Yield – It may be helpful to calculate a Tax Equivalent Yield in order to compare the tax liability of your interest payments of different types of securities which to build your Laddered Portfolio. This will help you make an “apples-to-apples” comparison of the actual income you would receive in comparing your different options. Your Financial Advisor or Tax Professional should be able to help you do this.
Developing Laddered Portfolios may take sophisticated trading software to do properly. Investors may want to consider consolidating larger positions in order to avoid excess trading costs. You can learn more about Investment Strategies at our website www.SWRetire.com as well as learn more about our full service Financial Advisory practice.
Views, opinions and analyses expressed in this presentation are those of Southwestern Retirement and not those of Independent Financial Group, LLC.
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Southwestern Retirement Planning Advisors, Inc. is not affiliated with Independent Financial Group LLC.
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