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Looking for a lower risk investment strategy? Maybe it's time to build a bond ladder

by , 09 July 2014

Since the financial crisis, interest rates the world over have been at record lows. But with rates so low, it can be difficult to yield decent returns without taking on a lot of risk.

For some investors, the rollercoaster ride of the stock market is too risky an undertaking. Investing in bonds could be the answer…

The benefits of investing in bonds

If you’re looking for a regular income with less risk than shares, bonds could be perfect for you. Bonds don’t give you the safety of holding your cash in the bank, they do have risks, Phil Oakley in Money Week explains.

There’s always the possibility the issuer will default on interest payments or paying back your money at the end of the bond’s term.

There’s also the link between the price of bonds and interest rates to worry about. When interest rates rise, bond prices fall. When interest rates drop, bond prices rise.

And with the Reserve Bank looking likely to hike rates once again, this can put a lot of investors off.

But the good news is, there’s a way you can reduce the risks associated with interest rates. And in the process gain from a regular income.

You just need a bond ladder.

The ins and outs of a bond ladder

A bond ladder is a portfolio of bonds. Each rung in the bond ladder has a different maturity date. A bond’s maturity date is when it pays back its face value.

Let’s look at an example…

You have R100,000 to invest in your bond ladder. So you split that into five equal parts of R20,000 for each rung of your ladder. Each rung has a different maturity. For example, maturities of two, four, six, eight and ten years.

A bond ladder works to your advantage because the bonds mature at regular intervals, every two years in our example. For instance, when your two year bond matures, the longest maturity bond you now have is eight years.

You’d then invest in another ten year maturity bond. If interest rates rise within those periods, your income will also rise. If rates are lower you can hold off till rates rise as you’ll only have a portion of your portfolio not invested.

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The benefits of a bond ladder

A bond ladder reduces the risks associated with interest rates. And you get a regular income in the process.

And with bonds, you know exactly how much interest you’ll receive and when they’re going to mature. This makes it easy to plan your next move.

Investing in corporate bonds in SA can require a large investment, but you could look to exchange traded funds too. But you can invest in government bonds from R1,000.

So there you have it, why a bond ladder may be right for you if you’re looking for a lower risk investment strategy.



Looking for a lower risk investment strategy? Maybe it's time to build a bond ladder
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