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Time for a Ladder?

Chris Cagle

I’M A 70-YEAR-OLD retiree with a conservative fund portfolio. I have 65% in short- and intermediate-term bonds, Treasury Inflation-Protected Securities (TIPS) and cash, with the other 35% in stocks.

Last year was a rough one for retirees. Rising interest rates and unexpectedly high inflation resulted in a losing year for stocks and bonds. My bond funds lost some 10%. It was one of the worst annual losses for bonds ever. Bonds have only lost value in five of the past 45 years, and the largest previous decline was a 2.9% loss in 1994.

But there was a silver lining: Bond yields are up. My mix of short- and intermediate-term bond index funds has a 30-day SEC yield—a calculation based on the 30 days ending on the last day of the previous month—of more than 4%.

That may look awesome if you’re just now moving cash into bonds. But if you’ve invested in bond funds for a while, you understand that yields are up mainly because rising rates have driven share prices lower.

This long-overdue increase in interest rates got me thinking about my bond funds. Should I hold on to them or purchase individual bonds to lock in today’s higher rates? Does it make sense to build a bond ladder? With inflation stubbornly high, would it make sense to build that ladder with TIPS?

None of these is a bad option. What’s best depends on your reason for investing in bonds. My main objective is income, but the preservation of principal and diversification matter, too. I use a version of the bucket strategy to help pay for retirement for my wife and me. With this strategy, I divide my portfolio into multiple containers, in my case segmented by years.

I have my IRA at Fidelity Investments. For years one and two, I invest in Fidelity Government Cash Reserves (symbol: FDRXX). For years three through five, it’s Vanguard Short-Term Bond ETF (BSV) and the iShares 0-5 Years TIPS Bond ETF (STIP). I hold Vanguard Total Bond Market ETF (BND) and iShares Broad USD Investment Grade Corporate Bond ETF (USIG) for years six through 12. My U.S. and international stock and real estate index funds are for years 13 and beyond.

I take monthly withdrawals from my cash bucket, which is refilled by interest and dividends from the other buckets. I’m not yet at the age where I have to take required minimum distributions (RMDs), but my annual withdrawal rate is close to what my RMD would be at age 73.

How would a bond ladder fit into my retirement income strategy? I’m not a fan of longer-term bonds because there’s too much interest rate risk. Still, by committing to hold bonds to maturity, I shouldn’t ever have to sell at a loss. If I were to build a bond ladder, I’d probably build a seven-year TIPS ladder for years six through 12—when my wife and I will both be 82—and then keep my stock and real estate index funds for years 13 and beyond. Doing so today would mean selling my Vanguard Total Bond and iShares Corporate Bond at a loss.

I like the idea of the added inflation protection and the greater certainty that comes with holding individual TIPs to maturity. Still, I’m not sure the strategy makes sense for me. I like simplicity. My bucket strategy is easy to manage. By contrast, building a bond ladder would involve a higher level of complexity. That’s especially true with TIPS. I’d have to worry about coupon rates, accrued principal, inflation factors and real yields to maturity, plus I’d need to buy the individual bonds on the secondary market.

More important, I didn’t build my bucket strategy for direct annual liability matching—that is, selling securities each year to fund that year’s expenses. For now, I’ve concluded that an acceptable alternative to a TIPS ladder is a combination of TIPS funds and other bond funds with average durations that match my short- and longer-term spending needs.

Chris Cagle retired from his career as an IT manager in the financial services industry in 2019. He now spends his time writing on his own site, RetirementStewardship.com, volunteering at his church, and hiking and fishing when he gets the chance. Chris has also written three books on retirement, Reimagine Retirement (2019), The Minister’s Retirement (2020) and his most recent, Redeeming Retirement: A Practical Guide to Catch Up (2021). Chris and his wife have been married 50 years and have six grandchildren.

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