The InterPrime Newsletter

By The InterPrime Team

The InterPrime Newsletter - Issue #13 - Leveraging Bond Ladders & a market update

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The InterPrime Newsletter
The InterPrime Newsletter - Issue #13 - Leveraging Bond Ladders & a market update
By The InterPrime Team • Issue #13 • View online
“When an economy or market is flushed with excess liquidity, people start to invest in unrealistic possibilities.” ― Naved Abdali
In this edition of the newsletter, in addition to providing a market update, we will be sharing a primer on how you can leverage bond ladders to generate steady income for yourself or your company with low risk.
Bond ladders are a fantastic tool that corporate treasurers use to manage risk and put their idle corporate cash to work.

Using Bond Ladders to put your idle cash to work
“It takes money to make money”
Some people believe it to the letter. While others completely disagree with it. The truth is somewhere in the middle.
The tools and strategies to grow the money you have move along a risk spectrum. On one side are speculative high risk where you hunt for home runs. On the other side are conservative slow grinders with reduced risk and potential for consistent profits. Neither is better than the other. You only need to understand the risk and potential outcome going into it.
This post will explain one of the more conservative strategies that can create cash flow and income. It is called a bond ladder and it can be used by companies and individuals.
If used correctly, the cash flow and income created from a bond ladder can:
  • Pay Expenses
  • Fund Business Objectives
  • Pad Emergency Funds
  • Extend the Life of Your Business
The beauty of a bond ladder is anyone can use them once you understand how to do it, and the income coming from them is consistent and can be counted on.
What Is a Bond Ladder
A bond ladder is a portfolio of bank CDs or bonds that mature at different times in the future. The strategy focuses on providing income while also reducing risk from changes in interest rates.
Buying bank CDs or bonds with different maturity dates forces you to stick to a plan. This keeps you disciplined and prevents you from trying to time the market. It also allows you to know when and how much you will get paid via coupon payments as well as principal payments.
As long as you reinvest the cash from each maturing bond. You can create a near perpetual money machine that pays you.
Benefits of a Bond Ladder
Create & Manage Cash Flow
Since bonds can pay you monthly, semiannual or at maturity. You can design and structure your bond ladder in any way you want or need.
Want monthly income? Check!
Want your bond ladder to cover a certain expense? Check!
Want your bond ladder to give you a lump sum payment in the future? Check!
Manage Interest Rate Risk
Interest rates change often, and sometimes dramatically. When you build a bond ladder with different maturity dates, you avoid locking in any single rate for a long time. The staggered maturity dates smooth out the fluctuations in changing interest rates.
Each time a bond matures you go to the market and purchase a new bond with a maturity date in the future. If rates have risen, you lock in a new higher rate for that portion of the ladder. If rates have fallen, you will unfortunately buy a lower rate. However, bonds already in the ladder will have previously locked in higher rates.
Building a Bond Ladder
Bond ladders are simple and straightforward to create. The 3 main pieces to building one are:
  1. Rungs
  2. Spacing
  3. Investments
Rungs of the Ladder
Deciding how much you plan to invest in a bond ladder will determine how many rungs it will have. This also decides how far in the future the ladder can be and how often you get paid.
Example:
$1,000,000 for bond ladder strategy could give you 10 $100,000 rungs. Each $100,000 rung would purchase an individual bank CD or bond
Tip: Most CDs and bonds pay you 2 times a year (semiannual). If you have at least 6 rungs of the ladder you can build it so you can get paid every month of the year.
Rung Spacing
Rung spacing is the time between the maturities of each bond. It is ideal to try to keep the time between maturities near equal.
Longer maturing bonds will generally pay you more. But they also increase your interest rate risk. You can reduce interest rate risk by shortening the bond maturities of the bond ladder.
Investments
A bond ladder can be built with various fixed income instruments. Each flavor has a different benefit.
Here are the most common:
  • Bank CDs
  • US Treasuries - credit guarantee from the US government
  • Municipal - potential tax advantages
  • Investment Grade Corporate - increased yield and liquidity
  • High Yield - increased yield
Tip: It is best to build a ladder out of higher rated bonds. A high yield bond can offer you increased yield. But they come with increased risk of default. Defaults can affect the goal of consistent income and if you get your full investment back.
How a Bond Ladder Works
Remember, with bond ladders you invest in multiple bank CDs or bonds with different maturities. As each bond matures, you reinvest in a new bond with the longest maturity you picked for the ladder.
If interest rates rise, you buy a new bond with a higher rate. If interest rates fall, or stay the same, old bonds are locked in at a higher rate.
The example below is for illustration. We picked 8 years for ladder length. With 2 year rungs.
Two years in the future, Bond 1 matures. You reinvest that money in a new bond at the maximum maturity. In this example, rates rose - hurray!
You would continue this process for as long as you wanted the ladder in place.
There are a million strategies and tools to make money investing. The bond ladder is one of the more conservative ones. You build it how you want, and have a reasonable expectation of what you will get.
The various fixed income assets and maturity dates help you customize it. All while letting you manage cash flow and reduce your interest rate risk.
If you value cash flow and income you may want to consider a bond ladder. They can help you both personally and for your company.
August 2021 Markets Update
September is notorious for being the worst month for financial market performance. It is dubbed, “The September Effect”. This should have investors prepared for a media onslaught of bearish leaning news takes.
History is no guarantee of future performance. So we don’t blindly assume September will be a disaster. The key, as always, is to remain flexible in your thinking and always prepare for risks.
Bonds & Rates
The annual Jackson Hole Economic Policy Symposium was just completed. This annual meeting has marked  shifts in US economic policy in the past. This year, there were no fireworks. But we did gain insight into how Chairman Powell is viewing the economy and what changes could be coming.
Asset Purchase Tapering & Rate Hikes
To help support the US economy from COVID, the Fed has been buying $120 billion worth of assets in the open market a month. $80 billion of Treasuries & $40 billion of agency backed mortgage securities.
Market watchers have been anticipating when this program would be wound down, because it could be a signal interest rate hikes are coming.
During Chairman Powell’s speech he tackled the idea that asset tapering and interest hikes are connected.
He signaled he is in favor of asset tapering in the near future when he said, “if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year (2021)”.
He then went on to signal that while the US economy is recovering, it is not completely out of the woods, “Even after our asset purchases and our elevated holdings of longer-term securities, we will continue to support accommodative financial conditions.”
“Accommodative” is code that interest rates will remain low and hikes are not going to be in tandem with asset tapering. But he went even further to make it crystal clear when he said, “The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test.”
It does not get more clear than that.
Inflation
Everyone is feeling the bite of inflation currently. We even talked about how it was ramping in our May Newsletter, “Inflation, Do You Feel It Yet?”. Yet, Chairman Powell does not see inflation as a long term worry. He labels it as “transitory”.
He even drilled down further on this thinking when he said inflation, “is so far largely the product of a relatively narrow group of goods and services that have been directly affected by the pandemic and the reopening of the economy”. While this could be true, everyone is feeling it in the pocketbook.
The Fed maintains that they are focused on getting the economy back to full employment. And that inflation needs to be above 2% for a maintained period of time before it will become a larger issue.
Take away: Asset purchase tapering should start near the end of 2021 / early 2022. Interest rates will remain low. Borrowers get the benefit, investors not so much. You can read the full Jackson Hole speech here.
Stocks
Stock indices locked in the 7 month of gains at the close of August. That is the longest streak for the S&P 500 since a 10 month run ending in December 2017. There is likely little to slow this train down.
The clarity we got from Jackson Hole says interest rates are to go unchanged through the remainder of 2021. That means the path of least resistance for stock indices is higher.
S&P 500
S&P 500
Take away: Historically September has led to flat returns for indices. A pause in trend does not change the trajectory higher.
Bitcoin
Bitcoin has now moved out of the consolidation phase. Buyers have gained the upper hand.
One can assume the near term trend is higher. While nothing moves in a straight line. It is conceivable to see Bitcoin back near $59k to $62k.
Take away: Buyers during the consolidation phase are in the driver seat. Price dips may be shallow.
Wrapping Up
If the Fed does start to taper asset purchases in 2021 we may see a marginal increase in rates thanks to supply and demand. Overall, it would be negligible due to the Fed commitment to keeping rates near zero.
Equities could get stuck in the mud if the September Effect does play out. That would mean a possible flat to slight negative monthly return. One month does make a trend. And the current trend remains pointed higher.
Please reach out to us if you have questions, or if you want to talk about markets.
Did you enjoy this issue?
The InterPrime Team

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