What Types of Bond Should You Buy to setup a Municipal Bond Ladder
A municipal bond ladder consists of purchasing multiple municipal bonds of varying types and maturities in order to assemble a diversified portfolio. Consult our article What Municipal Bonds to Buy to get some tips on selecting higher quality municipal bonds.
Why create a Municipal Bond Ladder?
There are several reasons to create a ladder of bonds.
It hedges against interest rate fluctuations. Because you own bonds of different maturity, if interest rates go up, your yield will go up as new bonds are purchased to replace matured bonds.
Having the ladder of bonds will help achieve diversification of bond maturities, types of bonds, locations, and credit quality.
Steady income is achieved with a ladder of bonds. Bonds will be paying interest many months of each year when you have a portfolio of securities. Purchasing of premium and discount bonds will help diversify your income stream.
With a ladder of municipal bonds, you will receive a lower rate of interest when comparing against long term bonds. But with long term bonds you’re stuck for an awful long time, which leads to problems as interest rates fluctuate or municipalities default.
Creating a Municipal Bond Ladder
Buy an equivalent number of bonds maturing in each year for the total length of the ladder. Some professionals have suggested having an average bond maturity of three and half to four and half years, or a short-term to intermediate term bond portfolio. To create a ladder for this type of portfolio we will purchase bonds of one, two, three, four, five, six, and seven year maturities. When the bonds maturing in one year have matured after waiting one year, we will then take the proceeds to purchase a bond maturing in seven years, extending the ladder by one additional year. We will continue this technique in future years.
We should own at least 2 to 3 bonds in each maturity class with each bond weighing in at $25,000 or more to achieve good pricing. It is clear that creating an individual bonds municipal ladder requires portfolio of at least $500,000.
As we mentioned in the past, always use two or more brokers, never buy online, stick to high quality issues, buy new issues when possible, and check Emma for pricing and financial statements on an issue before you buy.
Monitor your portfolio
After you purchase your bonds, you need to monitor the states and projects involved for problems. Watch out for ratings downgrades from firms like S&P, Moody’s, and Fitch. Look to see if a ME shows up on your statement, meaning a material event has occurred. If you cannot get financial statements for the municipalities your own, try to get minutes of public meetings. If you don’t subscribe to local newspapers of municipalities, at least watch the newspaper’s website every day and set up alerts on Google News with keywords relating to their municipalities your own.
Additional Related Municipal Bond Educational Articles:
What are municipal bonds?
How to Research Municipal Bonds
The Risks of Owning Municipal Bonds
How to Buy And Sell Municipal Bonds
Municipal Bond Mutual funds – Municipal Bond Managed Accounts
What Are Closed-end Municipal Bond Funds?
What are Municipal Bond Exchange Traded Funds or ETFs
How to Make a Municipal Bond Ladder
How to Select Municipal Bonds
Municipal Bond Trading Example
How to Perform Active Municipal Bond Management
Municipal Bond Books and Educational Resources