Building bond ladders for a low-interest-rate world

The bond ladder, once considered the bedrock of safe and predictable retirement income, has become a tougher sell for some advisers in this era of rock-bottom bond yields.
While bond-ladder purists still believe a portfolio of bonds set to mature at regular intervals over a 10-to-15 year period is the surest way to provide clients with steady and predictable income in retirement, the stubbornly-low state of interest rates are forcing some advisers and clients to rethink or tweak the strategy.
“I’ve got some clients who have been saying over the last 10 years that rates are going up, so they refused to buy anything longer than 18 months’ maturity, because they want to stay short term to be able to take advantage of the higher rates,” said Jonathan Swanburg, an adviser at Tri-Star Advisors.
When structured for retirement income, as most bond ladders are, the rungs of the ladders are made up of bonds maturing annually over the first 10 or 15 years of retirement. But if clients are too worried about trying to time a rising-rate cycle, it is near impossible to build a bond ladder that can go out a decade or more, especially since most ladders are constructed prior to a client’s retirement.
Mr. Swanburg said before rates hit the floor following the 2008 financial crisis, he used to build bond ladders with bonds going out as along as 30 years, “because there would be a significant difference in yields in the longer-term bonds.”
He is now building bond ladders for periods of between just two and 10 years.
“It doesn’t make sense to go out long on the yield curve when the 30-year Treasury isn’t giving you much more than the 10-year,” he said.
Bryan Koslow, president of Clarus Financial, said he is still using bond ladders for clients, but that the fixed-income portion of portfolios is now being watched for loading up too much risk.
“In the past, the ladder was designed for predictable income,” he said. “But today, with rates near zero, we want to prepare clients for rising interest rates, so we may replace some of the bond ladder exposure with some financials or floating-rate bonds that will perform better as rates rise.”
But Bert Whitehead, founder of Cambridge Connection and the Alliance of Comprehensive Planners, said using bond ladders for anything but safety in retirement is a mistake and misses the point of the bond ladder.
“Safety trumps yield,” he said, repeating a mantra he has been saying for decades when making the case for bond ladders as a retirement income vehicle.
Even though yields are low, and more of a client’s portfolio will be needed to build and maintain a bond ladder, Mr. Whitehead said there is nothing more important in a retirement portfolio than steady and predictable income.
The basic strategy used by Mr. Whitehead involves using zero-coupon U.S. Treasury bonds to build the ladder rungs to fill in the gap between annual income needs and what is being provided by Social Security.
“We insist on knowing how much the client needs to maintain their lifestyle, and if they’re getting something from Social Security, we make the ladders for whatever that gap is,” Mr. Whitehead said. “The yields are low so you will be more in bonds and less in stocks, but when you have a 15-year income stream that is backed by the U.S. Treasury, you don’t have clients panicking and jumping in and out of the market when things get volatile.”
Once the bond ladder is built out to cover the first 15 years of retirement, any remaining retirement assets are allocated to riskier investments, including stocks, that are designed for growth.
“We’ve got lower yields, so we end up with a higher weighting in bonds,” Mr. Whitehead said. “For some people that means you can’t retire as early as you think you can. But that’s what happens.”