Is it time to hedge interest rate risk with a bond ladder? We are living in a period of historically low interest rates. The United States Federal Reserve has been buy US treasuries and thereby driving down interest rates. They are doing this to help promote investment in increased employment. They are succeeding to a degree as the United States unemployment rate has fallen over the last few years from ten percent to eight and two tenths percent. Reliable predictions have the unemployment rate at eight percent or lower by the end of the year. United States manufacturing is gaining and corporate profits from the likes of 3M, ATT, Verizon, and GE are up. Thus the Fed has decided to forego more stimulus. Some investors assume that the worst is over. They may decide to invest in Apple for the dividend, invest in Hewlett Packard for a rebound, or take a run at investing in Kodak during bankruptcy. But others are putting their money in AAA bonds or US Treasuries as they wait for the economy to gain steam. If you are one of these folks, how does an investor avoid getting stuck with low interest rate bonds as interest rates rise? Part of the solution is to hedge interest rate risk with a bond ladder.
What Is a Bond Ladder?
A bond ladder is an investment device wherein investors purchase bonds (or treasuries or CD’s) with relatively short maturities. To hedge interest rate risk with a bond ladder an investor can have all bonds mature at the same time or stagger the maturity dates. For example, an investor may purchase 1 year bonds, CD’s, or treasuries. He can buy them all at once and have them mature all at one or he can stagger them so that a forth mature every three months. In either case he will not get caught with long term securities that become devalued as interest rates rise. The down side when one decides to hedge interest rate risk with a bond ladder is that he is usually not holding long term bonds when interest rates fall. Thus he does not benefit from bond appreciation to any great degree. If your answer to what is a good investment in this environment is that it has to be a conservative investment, then to hedge interest rate risk with a bond ladder may be the ideal choice.
Balancing an Investment Portfolio
Consider this. The economy is improving and there may well be some very good long term investment options just around the corner. But, the European debt dilemma could come back with a vengeance or a spectacular crash of the Chinese real estate bubble could through the world economy back into recession. So, hedge interest rate risk with a bond ladder with the fixed income part of your investment portfolio. The older you are and the closer to retirement you are the larger portion of your portfolio should be allotted to such a conservative approach. Dividend stocks or the big cap and stable variety are also a standard conservative approach. If you are looking to hit a home run by investing in penny stocks in this market, however, make sure that your fundamental analysis is sound and that you keep up to date with market sentiment.