I always knew the time would come for me to learn how to build a bond ladder.
That day has arrived.
Today, a step-by-step tutorial on how (and why) to build a bond ladder, based on what I’ve learned while building mine. They can play an important role in providing predictable income in your retirement years.
Bond ladders now have a role in my retirement.
Should they have a role in yours?
Today, a step-by-step guide on how (and why) to build a bond ladder, based on what I've learned while building mine. Click To Tweet
A special shout-out to reader “DW,” who was the inspiration for today’s post. In a recent e-mail exchange, he was asking some questions about The Bucket Strategy and I mentioned our new bond ladder approach for Bucket 2. He replied with the following:
“I’ve tried to use the search option on your blog to find the article on what you’ve done regarding the bond ladder. Can you reference the blog date so I can more quickly locate this information?”
This one’s for you, DW. I hope you find it helpful as you implement your bucket strategy.
How To Build A Bond Ladder
A few years ago, I had a conversation with my friend Jim at RouteToRetire and suggested the use of a Bond Ladder as an element in his retirement drawdown strategy. He (wisely) implemented a bond ladder at that time and avoided the exposure I experienced in last year’s bear market with my bond mutual funds. He wrote an update about the holdings in his December 2022 post Opening The Books To Our Investment Portfolio, which was my trigger to start implementing my own Bond Ladder. In fact, his article was written on Dec 6 and I purchased our first “rungs” on Dec 7.
In addition to the “nudge” from Jim, there were three major changes in our investment portfolio in 2022 that were catalysts to building our first bond ladder:
- We said Goodbye To The 401(k) and converted our 401(k) into personal Vanguard IRA and Roth accounts.
- We converted our Vanguard individual accounts to brokerage accounts (mentioned in the article above).
- We learned how to build a bond ladder, and began construction of the first few “rungs” in December.
As I mentioned in the “Goodbye” post, one of the reasons we closed our 401(k) was the fact that having the funds in a Vanguard Brokerage account gave us the ability to build a bond ladder, which wasn’t something we could do within our 401(k). Another factor was that increasing interest rates have opened up opportunities to “lock in” more attractive yields than have been available in the past several years.
Within my 401(k), I had a Stable Value Fund which is not available in the “public” Vanguard fund options. These stable value funds invest in guaranteed investment contracts (GIC’s) with insurance companies and are common within 401(k)’s, offering a higher interest rate than is available through conventional means. One of the reasons I waited 4 years after retirement to close my 401(k) was my inability to replace this feature in a low-interest rate market environment. Now that rates have increased, it made sense to proceed and I chose a bond ladder as one of the mechanisms to replace my 401(k)’s Stable Value Fund. For the record, I classified the Stable Value Fund as a bond allocation when doing my asset allocation since I considered that the most accurate representation of its characteristics.
For more detail on Stable Value Funds, read Morningstar’s Unpacking Stable Value Yields.
What Is A Bond Ladder?
In the simplest form, a bond ladder refers to the strategy of investing your money into bonds (or CDs) with staggered maturities, resulting in a known income stream on a known future date. For example, if you purchase an Invesco BulletShares 2025 Corporate Bond Fund (BSCP), you will own a basket of corporate bonds, all with expiry dates in 2025. The fund will terminate on December 15, 2025, and your yield will be fixed based on the yield to maturity (YTM) at the time you purchased the fund, less any defaults (YTM is 4.83% as I write these words on 2/7/23).
When the fund is liquidated in December 2025, the resulting monies can either be used for the next year’s spending needs or reinvested via the purchase of a new “rung” at the “top” of your existing ladder. Following is an example from a recent Morningstar article “Bond Ladder ETF’s Can Help Investors Climb Higher” which illustrates a rolling 3-year bond ladder:
Why Build A Bond Ladder?
As anyone who owned bond mutual funds last year knows, they suffered a decline in value as interest rates increased (bond values are inversely related to interest rates). The longer the bond’s duration, the greater the decline. If you were required to sell some bond funds last year to access money to fund retirement spending, you would have incurred a loss. By replacing a bond mutual fund with specific maturity date ETF’s, you are able to structure your bond allocation into predictable future cash flows, reducing the risk of having to sell a portion of your bond mutual fund at a loss to meet future spending needs.
The purpose of Bucket 2 in The Bucket Strategy is to generate mid-term income (years 4-10 in my structure), with higher returns than Bucket 1 (Cash) and lower risk/volatility than Bucket 3 (Stocks). By building a bond ladder within Bucket 2, I am able to generate a known return that will be available at a known future date with minimal risk.
When the maturity date arrives, the bond ladder gives you the flexibility to either:
- Use the funds to meet short-term spending needs (e.g., refill Bucket 1), or
- Reinvest it in a new rung on the ladder, depending on market dynamics and your asset allocation at the time.
For me, the primary reason to build a bond ladder is to build a predictable future income stream, regardless of what happens in the interim. That brings me some peace of mind and fits well within my Bucket Strategy mentality.
How To Build A Bond Ladder
Once you’ve decided to build a bond ladder, the key decisions are:
- How much will you invest, and at what maturities?
- How many “tranches” will you use to build your ladder?
- What vehicle will you invest in?
In our case, we have chosen:
- 50% of our annual spending needs, starting in late 2023 (to cover 50% of 2024’s spending needs).
- We’ll target 2-3 tranches (portions of the total) over a 12-month horizon to build a 5-year ladder (2024 – 2028).
- We will utilize CDs for the short-term rungs and BulletShare ETFs for the longer-dated rungs.
We implemented our first “tranche” in December 2022, investing $50k in the first few “rungs” maturing from Sep 2023 until Dec 2025. We used CDs for maturities through mid-2024 and Invesco BulletShares fixed-income ETFs for the Dec 2025 rung (BSCP). A week later, we added a second tranche of $40k invested in BulletShares for 2026 (BSCQ) and 2027 (BSCR).
At this point, our Bond Ladder is as follows, with the “bottom rung” expiring 9/15/23 and the “top rung” expiring 12/15/27:
Gotta love those yields! Smile.
(It’s worthwhile to note that BulletShares has a Bond Ladder Tool available on their website which is worth your time to review if you’re considering building a bond ladder.)
Building Your Bond Ladder With Vanguard
For the sake of this article, I decided to add one more “rung” to the ladder, taking screenshots along the way as I executed the order in my Vanguard Brokerage IRA on Feb 4. To get started, click “My Accounts”, then “Buy & Sell” from the Transactions tab. At that point, a window pops up where you can enter a ticker symbol. If you’re going to proceed with a BulletShares purchase, simply enter the symbol (e.g, BSCQ for the 2026 Corporate Fund) and proceed.
If you’d rather look at options for other products, scroll down the page and you’ll see a section titled “CD’s & Bonds”, which includes options to “Buy brokered CD’s” and “Trade Bonds & U.S. Treasuries”. Since I haven’t purchased any Treasures yet for my ladder, I decided to investigate that option. After clicking which account you’d like to make the transaction in (I chose my IRA), a screen pops up that compares yields for both Brokered CD’s and US Treasuries, as follows:
I’ve decided to add my next rung in mid-2025, so the “2 years” column is the one I’m interested in. Since Brokered CDs (4.75%) are offering a higher yield than Treasuries (4.54%), I changed my mind and decided to go with another CD for this tranche. Clicking on the 4.75% in the 2 Years column, I was presented with the following:
Notice that the first two options are “Callable”, which means they may get “called” (paid out) prior to my desired maturity date. You’ll want to avoid Callable CDs when building your ladder since it creates variability on your payout date. As I look at the first two CDs that aren’t callable, I notice that the First Natl Bk Omaha (4.55%) only pays semiannually, whereas the Wells Fargo Bank Na (4.55%) pays monthly. All else being equal, I’d prefer the monthly payout, as I suspect it would result in a slight compounding gain, so I select the Wells Fargo CD and hit “continue”, which brought me here:
At this point, you choose how much you’d like to invest and hit continue. Since yields have dropped a bit since my first two tranches, I decide to go conservative with this purchase and only invest $5,000 in the CD. After you click “continue”, it requests confirmation that you’d like to execute the order. Once you click confirm, it brings up your confirmation and you’re all set.
My bond ladder now includes the additional “rung”, which I’ve highlighted in yellow below:
Should You Hold Your Bond Ladder In An IRA, Roth, or Taxable Account?
We decided to build our bond ladder in our Vanguard IRA brokerage account utilizing funds previously invested in our Before-Tax 401(k) Stable Value Fund. We chose the IRA instead of the Roth to optimize tax location efficiency for the bond holdings. You can read more on the tax location efficiency topic in Our Retirement Investment Drawdown Strategy, which includes this table summarizing the topic:
Bottom Line: you want your highest growing assets in your Roth where they’ll grow tax-free, and your bonds in your IRA where they’ll eventually be taxed as income. Given that we still have “too much money” in our Before-Tax IRA, the reality is we have to hold something there, and bonds make the most sense from a tax efficiency standpoint. Bond returns are typically taxed as income (the exception being Muni Bonds, which are tax-exempt and should be held in taxable accounts), so the “penalty” for having this growth be taxed as income is less punitive than other asset classes.
The challenge is that having these funds in our IRA will require a taxable distribution should we choose to use the proceeds to refill Bucket 1. However, we face the reality that we’ll be drawing from the IRA regardless at some point, given that our taxable holdings are insufficient to cover our entire retirement spending. So, it’s somewhat a moot point, though it will be something we take into consideration as we’re finalizing our Annual Roth Conversion dollar amount each year. Also, we’d prefer to hold off on tapping our Roth investments for as long as possible, so it makes sense to invest our Bucket 2 funds in the IRA, which we’re planning on tapping before the Roth.
Investment Choices For Your Bond Ladder
We decided to build our bond ladder using CDs and Invesco BulletShares, but there are other options. My decision for utilizing BulletShares was driven by 4 factors:
- They’re easy to buy (and sell, if necessary) through our Vanguard brokerage account.
- The yields were slightly favorable to other options, and their expense ratio is low at 0.10%
- I like the diversification that comes from holding a portfolio of corporate bonds.
- I like knowing the bonds will all mature at a specific time and the money will be there when we need it.
One other appealing aspect of the BulletShares is the fact that they allow you to decide what type of bonds you would like to use to build your ladder. While I chose Corporate Bonds, they also offer High-Yield Bond Funds, Emerging Market Debt Portfolios, and Muni Bond portfolios. For the record, I do not receive any compensation from BulletShares and am recommending them solely on the basis that I’ve found them to be good products for my needs and feel they’re worth a look.
If you’re building your Bond Ladder in a taxable account, I’d encourage you to investigate municipal bonds, which are tax-free and may yield higher after-tax returns. If you’re a fan of Treasuries, they would also be a solid choice. They can be purchased directly through the Treasurydirect.gov website, which I use to buy my annual allotment of I-Bonds. In fact, I-Bonds are another option that could be used for your bond ladder, though I view them as a longer-term holding as a hedge against inflation and do not count them as “rungs” on my ladder. If you dislike the Treasurydirect website as much as I do, you should also review this post from The Finance Buff that explains how you can buy Treasuries through online brokers (thanks to Eric @ TwoSidesofFI for sharing the link).
Individual Corporate Bonds are also an option, though I prefer the diversification that comes with the BulletShare product. The biggest risk you have with the bond ladder strategy is default risk, and that risk is elevated if you decide to buy individual bonds instead of the entire portfolio that’s available with the BulletShare approach.
Conclusion
Over the past few months, I’ve learned a lot about how to build a bond ladder and have come to the conclusion that they are a valuable tool in our retirement portfolio. Their primary benefits are:
- They provide a predictable and secure future cash flow.
- The recent increase in bond yields makes them a more attractive asset.
- A bond ladder is easy to implement and manage.
- A ladder is a better tool for Bucket 2 than bond mutual funds (reduce the risk of having to sell at a loss)
- They offer flexibility (you can either use the funds to pay for expenses or “roll it over” to a future rung).
If you’ve not yet considered building a ladder, I trust today’s guide on “How To Build A Bond Ladder” has informed you on the merits of the strategy and given you the tools you need to implement a ladder of your own.
For me, they make sense.
Do they make sense for you?
Only you can decide…
Your Turn: Have you implemented a bond ladder in your retirement withdrawal strategy? Has the recent increase in yields influenced your decision? Let’s chat in the comments…
Hi Just discovered your site. Reading past posts. Feel good that we have very similar portfolio styles and I love seeing this post. I fortunately rolled all my fixed income into Stable Value in Feb. 22 from bond funds because I believed the Fed and for the last 4 months have been creating a 3 yr. bond ladder. I’ve used Fidelity to buy 1, 2, and 3 year secondary market treasuries, non callable CDs, AND put about 20% into VMFXX and FDZXX money market mutual funds yielding ~4.35 because the yields increase as rates go up. I also like the liquidity. When the Fed pauses I will consider Bulletshares. I did not know about them! While they do have an expense ratio, I like the combination of certainty of maturity, liquidity, and how the fact it’s not a single bond reduces risk as far as corporate default. Thank you!
Glad to have you on “the team,” Jeff. Similar portfolio styles, indeed. Glad the info on Bulletshares was new for you, always good when I can share something new for the readers.
You don’t necessarily have to jettison the 401(k) to build a bond ladder. My Fidelity 401(k) has a feature called BrokerageLink which gives me access to thousands of investment vehicles beyond the dozen or so in the employer’s 401(k). In exchange, any withdrawals are a multi step process: sell the investment in BrokerageLink, then transfer it to the 401(k), then withdraw from the 401(k) to another account. Still, it’s worth it to pick your own investments rather than what some committee chose for their employees.
LL, I remember the comments in my “Goodbye 401k” post about Fidelity having more features than VG’s 401k. Your fortunate to have the option, though it sounds like the withdrawal headaches are a common feature of both VG and Fidelity, unfortunately. That was the primary reason I closed the 401k.
I don’t mind the extra steps. It just requires me to plan big money moves, especially near the end of the calendar year. It takes about 10 days for the dust to settle with all the moves. I am forced to stay in this mode for a few more years as I used the IRS Rule of 55 to retire early. Once I hit 59.5 I could move most of it – undecided whether I will. There might be a short period where I shouldn’t touch the Roth 401(k) as there is that 5 year startup period – the result of my company getting acquired by a much bigger company which created a new Roth 401(k) for me. There isn’t much there, but it is a thorn in the side of me moving everything out. There’s, no mathematical reason to do it, only a convenience reason.
Fritz, nice layout of the process and your thinking behind it. You wrote,
“One of the reasons I waited 4 years after retirement to close my 401(k) was my inability to replace this feature in a low-interest rate market environment. Now that rates have increased, it made sense to proceed and I chose a bond ladder as one of the mechanisms to replace my 401(k)’s Stable Value Fund.”
Even with increased interest rates, the SV fund will likely continue to match if not outperform a short term ladder, with more simplicity. SV rates are increasing too. So I’m curious as to whether you did some math comparing them, or if something else contributed to the change.
Michael, good point that there will always be some “Alpha” with the SVF, but somehow it seemed easier to swallow when I could get 4.5 – 5% vs. ~5.5% in the SVF. Less painful than 0.5% vs. 1.5%, though in theory the math is the same.
The main reasons I left the 401k were around the other 6 issues I highlighted in the “Goodbye” post, most of which focused on the difficulty in doing Roth conversions. SOOO much easier now that I’ve moved the funds into individual accounts.
Thanks for the reply. I went back and read the “Goodbye” post and now your move makes sense to me. I misunderstood that you had left purposely to swap the stable value fund for the bond ladder, in my view not a good reason.
FWIW, I am also still in my 401k, specifically to have access to the SVF, which is most of the account. It also has some company shares that may be “NUA’d” at some point, and an international stock fund in the Roth section. The SVF constitutes more than half of our fixed income holding, and I plan to keep until I have to get out at 65.
I converted my short term bond ETFs to a effectively a 10 yr bond ladder last year (year 1 retirement) for the reasons you mentioned. Due to the Fed’s very clear messaging of continued rate increases and at the advice of my “bond guy”, my ladder consisted of bonds/Treasuries/CDs that all matured (or had calls) within 3 years. Coincidently, I just had a little over 50% of my ladder mature last week and have got to make a call on how best to redeploy these funds. Strategy A: Buy bonds to fill out my 10 yr bond ladder regardless of market yields and rinse and repeat as they mature (similar to your 1st example above), or, Strategy B: Weigh the current market conditions/Fed tell signs/”market experts” and maybe keep maturities shorter term until/if say 5 yr + maturities hit __ yield. I suppose there is an argument for both. The good news is with current money market rates in the 4.5% range it’s ok to park the cash there and take a little more time cherry picking your bonds.
Always nice to have options, right? You’ll only know the best option with hindsight, so pick which one makes the most sense for you and don’t look back…
Hi Fritz,
I’ve been reading you for some time as I am 71 and on the cusp of making that all-important decision to exit the workforce. A small group of my friends have been meeting for several years to share what we termed the ‘financial intelligence team’. As the markets turned and interest rates rose, we recognized the need to move portions of our investments to bond/CD ladders. Starting in October of 2022, I built four separate one-year CD ladders, each with 3, 6, 9, and 12 month maturities. I staggered each ladder such that every month I will bank the proceeds of one of the maturing CDs and automatically roll over the base value to the next 12 month issue (with a new return rate). In that way I will capture the best possible rate from month-to-month without committing to a longer period. I use Fidelity, which calculates the highest available rate for a new CD each time the maturing CD pays out, thereby replacing the old with the new. Using a one year plan, I have the opportunity to monitor the time rate of change of CD interest payouts and can exit the ladder anytime the market ‘resets’ to a growth posture.
Keith, I love the idea of your “FIT” team, may have to incorporate that into the new Retirement Mastermind Group I started a few weeks ago. Thanks for being a long time reader, much appreciated!
With the help of our FA, we began to implement a 10-year TIPs bond ladder in 2018 when we retired. The intent of the bond ladder was to match it against all expenses, both fixed and discretionary, in future years and since income was expected to vary the amount of the bond varied. The ladder got built over a couple of years when buying conditions for TIPs were favorable so there were periods when there were a couple of empty rungs. Empty rungs were usually filled in with brokered CDs, particularly in the short term. Our ladder is about half of bond allocation and our bond allocation is about half of our portfolio-the remainder is in bond ETFs which feed the bond ladder. When our FA introduced to TIPs I was clueless about them. Im only slightly more educated about them now as they are a bit complex. I was also slightly skeptical about them. I’ve become increasingly convinced of their value. Last year was an anomaly with high inflation but performed very well, much better than the bond and stock ETFs-they really were the only thing in the black other than a small slice of commodity fund. As noted great time to buy bonds, including TIPs. Good article.
Rob, great timing to get into TIPS, they certainly performed well in the recent high inflation environment. I keep a portion of my bond allocation in TIPS, but don’t consider them as part of my bond ladder.
Hi Fritz, good overview of your approach to the bond ladder, but I’ll point out the BulletShares are bond funds, not individual bonds. They have expense ratios of 0.10%. I have been buying individual T-bills, Treasuries and CDs with short-term maturities to fill out my Bucket One and Bucket Two (Years 1-8) within my Schwab IRA. As these short-term bonds mature, I’ll start lengthening the terms to replace VTIP and BIV (also bond funds with ER of 0.04%) with individual bonds that I can hold to maturity. Bond funds, including BulletShares, all lost money last year, because people needed the money! With your own bonds, they will mature when you need them. And individual bonds don’t have expense ratios!
Jim, BulletShares are bond funds, but all of their holdings expire in the year of the ETF, so they offer the predictability of individual bonds with lower default risk. If held until maturity, they won’t lose money like a bond fund, since bond funds never “mature.” It’s a key difference and the primary reason I went with them. Fair point about the expense ratio, but I’m ok with a 0.1% expense ratio in return for the entire portfolio of Corporate Bonds I’m able to buy through the BulletShare ETFs.
True, but individual T-bills, treasuries and brokered CD’s would also have lost money (declined in value) when interest rates rose. But, like BulletShares, the loss will not be realized if they are held to maturity.
My dad retired at the end of 2022, and I bookmarked this article to discuss a bond ladder strategy with him. Thanks!
Hi Fritz. Great article. I’ve been doing the same with Treasuries. I also dislike the Treasury Direct website but that’s the only game in town for i bonds. Not sure if you were aware but you can buy “regular” Treasuries via the Vanguard website. Auction settle prices (not secondary market) are $0 fee. Just another option.
Dennis V
I do a 3 monthsT-Bill ladder, so each month I have funds maturing that roll into another 3 month T-Bill. Generates about an extra $3,000/month in interest that is state tax exempt, which is why I never use CD’s.
If the market ever stabilizes, then more of these funds will roll into equities and out of bonds.
There is something to be said about simplicity especially in retirement portfolios. If you want to mess with CD or TIPS ladders, be my guest. The retail muni bond market is highly opaque and not for amateurs. The Vanguard Federal MMF is currently paying 4.57% State tax free. The incremental yields are essentially negligible. Why mess with them?
The only reason I consider it worth the “hassle” is to lock in the interest rate. Yes, MMF are competitive at the moment, but if interest rates decline (e.g., recession), you’ll have lost an opportunity to lock in the yield for a known duration. On the other hand, if rates increase, you’ll be ahead. I’d rather lock in a small % with “known” return. Personal preference, the beauty of “Personal” Finance!
Thank you, Fritz. Prior to this read, I had a vague notion of what a bond ladder was. Now I have a concrete example of what it is and how it works. And it makes perfect sense, especially in today’s rising interest rate environment. But alas, capital gain losses in my bond funds are proving to be very useful. They drop my AGI and this allows me to make Traditional-to-Roth IRA conversions without affecting my Obamacare subsidies. They allow me to “thread the needle” so to speak. But once I’m on Medicare, watch out. Bond ladders here I come. And this post will be a handy reference. Cheers.
You always work the angles, Mr. G. Well done executing some Roth conversions while protecting your Obamacare subsidy. Well played, my friend.
Not sure I understand the Bullet Shares. If I buy a real bond I know what it should pay at maturity. Is bullet shares the same? I got killed in bond funds last year.
Yes, BulletShares are the same. I know what I’ll get back in Dec 15, 2024 when the 2024 BulletShare matures. Works the same as an individual bond, though it’s comprised of a large basket of Corporate Bonds that all expire in 2024.
But you’re likely paying a premium to buy the 2024 bullet shares right?
Not based on my analysis. The only fee is the 0.10% annual fee, so I simply compare the yields vs. other options available. When I constructed the “rungs” in this article, the BulletShares were competitive with other options.
Thank you for the update. I have been investing since 1984 and it’s hard to believe I never bought bonds or CD’ s before. I only stashed money in mutual funds and money market accounts that paid 8 percent at that time for cash. Now in retirement I see the need to learn about the retirement bond ladder. It’s always changing. We will keep changing our strategy as time changes. Just think if money market accounts went back to 8 percent again. We would move money again for higher gain. Is that possible? Never say never. Keep the information flowing.
Never say never, indeed. I agree with you that “tweaks” to the tactical implementation on a broader strategy are appropriate when market conditions dictate. In this case, the higher interest rates justified the “tweak,” in my mind, of modifying my bond mutual fund holdings into known date BulletShares.
This is a great blog and really enjoyed learning more about bond ladders. We started a bond ladder portfolio last year because it is the best time to lock in high interest rates now. A year or two from now, rates could be a lot lower but the bond rates are locked in for a while.
I appreciate your comment on keeping money in old company 401(k) accounts to hold onto the benefit of hard to find stable value funds.
And…if interest rates continue to rise we’ll be kicking ourselves (but we always have the option of rolling over the expiring rung into a future rung paying those higher rates, so the risk is limited). That’s the way the game is played!
Once again Fritz you nailed it. In the process of saying goodbye to my 401k (TSP) (as you wrote about recently) and transferring (not converting) to Traditional IRA at VG as we speak. I too am in the fence about leaving it in MMF, but you make a pretty persuasive argument for a bond ladder. I think it has a prominent place in a Roth conversion strategy to stay within ACA subsidy/ tax bracket. Well done Sir!
Good timing Fritz! You must be reading my mind. I’m just in the progress of setting up a bond ladder myself.
If rates increase, then my MMF will immediately increase in yield.
If rates decrease, my mutual/ETF bond fund will increase in value possibly at LTCG rates.
Bonds are for safety. Stocks are for appreciation.
Awful lot of work to “lock in” a rate.
I agree with your analysis. The only thing I would point out is that I can access my BulletShares at a known time (maturity) for a known return. That feature isn’t available with a mutual/ETF bond fund, so I do think it’s worth the 5 minutes of work to “lock in” the rate.
Thanks for the great article! The statement about Treasuries in a taxable account peaked my interest as I have been wondering if I made a mistake doing that in taxable. I setup my 5 year bond ladder a couple months ago with Treasuries in my taxable account because I’m in my early 50s and will need access to be able to spend each rung as it matures. Added benefit is no state taxes. I actually thought it was the only option for an early retiree (without pre-59.5 penalties) until I came across this article about doing a switch between taxable and retirement accounts. https://www.bogleheads.org/wiki/Placing_cash_needs_in_a_tax-advantaged_account However I haven’t been able to find anyone who actually is doing this maneuver. It’s probably too late for me to change now but maybe it would help your other readers. Do you have any thoughts on it vs the Treasury ladder in taxable accounts?
M, I did exactly that type of maneuver in August 2022, which I discussed in this post:
https://www.theretirementmanifesto.com/the-bucket-strategy-in-a-bear-market/
Essentially, I called it a “fungible” exchange and “virtually” moved the money from my Roth to my Taxable account. Scroll down to the August bullet in that post for more details.
That said, you were wise to build your ladder in your taxable account, given your need to access the money pre-59.5. The only other option to you would be the “Rule of 55” which allows you to access 401k funds as long as you pull equal amounts of money out each year from age 55 – 59.5. As an early retiree, it’s critical to ensure you have a sufficient “Bridge” in taxable accounts to cover your spending until you can access your retirement accounts.
Great summary and really appreciate the details. I’ve been taking similar steps to shift pre-tax funds from an SV fund in my 401K to original issue, non-callable CDs in a Traditional IRA, now that interest rates are more attractive.
Also have been investing in laddered “bulletshare” ETF funds for several years using both Invesco and more recently iShares (iBonds Term Corporate ETF) funds. Curious if you looked at the iShares option? Both Invesco and iShares have a .10% expense ratio.
Dude, I wasn’t aware that iShares had a similar product to the BulletShares until I read your comment, so afraid I didn’t evaluate that option. Pleased to see the expense ratio is the same, but I haven’t done any analysis on comparing the yields. I suspect they’re very similar products, but that’s only an assumption (and, you know what they say about assumptions…)
The BulletShare’s are not like individual bonds or treasuries. If you buy a Bulletshare that matures say in two years, it does not invest in only 2-year bonds, it invests in numerous maturities. From Investco’s web site: “As BulletShares ETFs approach maturity, their durations decrease. In the last six months of the ETF’s maturity year, it is anticipated that the bonds in the portfolio will either mature or be called. Proceeds for these events will then be held either in cash or in cash equivalents such as US Treasury bills or commercial paper.” From it’s prospectus: “Unlike a direct investment in bonds, the Fund’s income distributions will vary over time and the breakdown of returns between Fund distributions and liquidation proceeds are not predictable at the time of investment.” “Income generated from the Fund is based primarily on prevailing interest rates, which can vary widely over the short- and long-term. If interest rates drop, the Fund’s income may drop as well. During periods of rising interest rates, an issuer may exercise its right to pay principal on an obligation later than expected, resulting in a decrease in the value of the obligation and in a decline in the Fund’s income.”
In the final year, these ETFs are collecting a growing balance of cash and the interest on cash is substantially lower than the bond which mature. Does that make sense??
I do realize that bonds mature throughout the “targeted” year, and it makes sense that those would be held in short term / liquid assets. Given the short duration of the holding, I suspect the impact on the overall return will be material, but you are correct in pointing out the issue. Time will tell what my actual yield is, but I suspect it will be close to the YTM cited at the time of purchase (I would expect they’d have to factor in some adjustment when quoting those YTM’s to account for the short term holdings at the end of the calendar year?).
I too was concerned about the YTM calc and contacted Invesco. The YTM figure does not consider the impact of lower (or higher rates) in the last year of tranche when funds are invested for a short term, before the fund matures. If short term rates are on par or highest than the initial YTM (when purchased), no harm. If rates are materially lower, then earnings in the final year will be lower than the initial YTM. However, that also means that the value of the fund may have increased from the date of purchase, which means you could sell the tranche a year before maturity for a small gain. You then have the option of investing the funds elsewhere, assuming you can find a better yield (you can always get the current YTM from the Invesco website) or you could reinvest the funds in a longer term tranche.
Fritz,
Thanks so much for sharing your details and thinking. Those of us a few years behind you are in desperate need of this information. It isn’t available anywhere else!
You have three years of cash in Bucket 1, right? So why not use iShares (iBonds) or Bullets for years 4-10 or 4-11? It looks like yours start in 2023?
The go only three or four years too? Why not cover eight years? Like years 4-11.
Then Bucket 3 could start 12 years down the road and be heavy in equities and commercial real estate.
Fair point, I’ve also thought about the reality that I could reduce Bucket 1 as the Bond Ladder maturities start approaching. For example, since I know I’ll have 50% of my 2025 spending needs maturing in Dec 24, I could drop Bucket 1’s cash by 50% of one year’s spending to “make room” for the bond maturity (e.g., not do any refills in the second half of 2024).
Your point about extending the ladder through the entire duration of Bucket 2 is certainly viable, and something to consider. Thanks for making the point.
I went down this path late last year (and in fact exchanged an email or two with Fritz, while Fritz agreed broadly, he didn’t think the “real” yields were quite attractive at that point), and setup the ladders for the next 5 years with 2 maturities per year (one Q1 and one in Q3). And this was the “cash” bucket. I was very reluctant to go past the 5 year TSY. This has lots of advantages (the TSY bond ladder that is), is perhaps the most secure investment, is reasonably liquid (if you wanted to trade away) and the interest is free of state taxes. Obviously the goal was to hold this till maturity and as they mature, use it as the cash bucket.
What I have since found then is that a SPIA offers a better return for lot less work (don’t get me wrong, I had fun setting the BL).
Try this on your own if you would like, you can use the SPIA calculator (from CS or Fidelity or immediate annuities.com) and a 400k investment with roughly 91k income per year for 5 years. The total return on this around $455k (+/-).
Whereas the BL you will have exhausted the money with the same withdrawal rate (and I “averaged” 4%)
Another perspective, file it under FWIW.
Raja, good point about annuities (Single Premium Immediate Annuity) being an alternative to the Bond Ladder approach. In fact, the reverse is also true. On a recent podcast interview on Two Sides of FI (it’ll be out this Sunday, 2/12) I made exactly that point. I didn’t evaluate the SPIA annuity when I constructed my bucket, agree it’d be a worthwhile comparison for anyone deciding between the two options.
Raja,
You may also want to look into something like PIMCO’s Income Bond CEF, PTY which pays north of 10%. I have been using it in my income bucket for a couple years now, and while the principal does fluctuate it continues to pay out > 10% on my investment and have added to it at higher yields along the way. Total return has also not been that far from the SPY during most of that time. In fact in the last year outperformed the SPY by about 8%.
Thanks, Fritz. Always interesting. I’ve been retired for 3 1/2 months and about to meet next week with my Fidelity advisor to discuss using Fidelity’s Core Bond Strategy. The Strategy seeks income from high quality bonds (A- or higher investment grade) from multiple sectors across varying maturities. Using the Bond Strategy, he recommended we fund our “protection” bucket with 4 years living expenses from IRA funds held at another firm’s brokerage account. I will ask about the benefits of this strategy versus the Bond Ladder approach you’ve outlined.
Glad to hear my timing was good for your discussion with Fidelity. I’d be interested in their response. The critical issue would be what maturity dates he’d suggest targeting for your “protection” bucket. If the maturities fall in line with your expected need for the cash, he’s essentially suggesting a ladder. If they mature later than your expected need for the cash, you’d be exposed to the same loss of principle that bond mutual funds experience if you need to sell them prior to maturity to access the cash.
Great post, Fritz, and it doesn’t hurt that you mentioned me in it as well! 😉 Thanks for that!
I always appreciate it when we’re doing something similar since it provides a little reassurance about what I’m doing. Although you can’t squeak out every possible penny using a bucket strategy and a bond ladder, it’s worth the small bit of potential missed earnings to be able to sleep more soundly at night regardless of what the market is doing.
Thanks so much for your bond ladder post and all of your posts, actually. As an early retiree, I have learned so much from reading them. I am curious as to why you’d choose the bond bullets for your longer-term investments vs longer-term CDs? I know there’s a slight yield difference, with bonds being a bit higher, but is it worth the additional risk to invest in the bonds? Is there a tax advantage to investing in the bonds vs CDs?
My decision was based strictly on the yields, Anita. Since the BulletShare fund owns a huge portfolio of Corporate Bonds, I’m assuming the default rate will be low. Only time will tell. There aren’t any tax advantages, unless you’re building your Bond Ladder in a taxable account with muni bonds.
Excellent bonds article!
I was never a fan of bonds and by reading your bonds execution it brought on a bond curiosity in me.
Thank-you very much!
Here is my take on stocks and bonds for Fritz’s DIY fans…
1. You must figure out your personal risk tolerance. Meaning, only you and only you will understand your pain when the market drops. Your financial adviser, your mom, your dad, your children and your best friends will not feel this pain.
2. Invest in the combination of stocks and bonds based on your appetite. Twig the ratio up and down along the way to match with your emotion when the market moves.
3. Once you have personally found the Goldie-lock stocks and bonds ratio and depending on your age and vitality…
a. Sit back on your back yard and watch the world turns
b. Travel the country and experience the lives of your fellow citizens
c. Travel the world and experience the lives of your fellow human beings
4. Live a full life so you will not have any regret at the end.
Good luck!
Great advice, TE. Those final four points are what it’s all about – the $ is simply the means to get there, and to enjoy it once you arrive.
What are your thoughts about using TIPs instead of nominal bonds for a bond ladder? The real yield on TIPS is pretty attractive right now by historical standards.
Also, would Treasuries/ agency bonds/ TIPS make more sense than CD’s or Corporate Bonds in a bond ladder for residents of high tax states as the interest from these is exempt from state tax?
I can’t get my desired bond allocation even after putting all funds in my tax deferred accounts in bonds, and end up holding some bond funds (largely munis) in my taxable accounts. Is there is way to use bullet shares to build a muni bond ladder in taxable accounts?
Great blog! Learnt something new about Bullet Shares from your post.
NAR, TIPS could certainly make sense, so long as you’re purchasing bonds with staggered maturity dates. Also, regarding your taxable account question, yes, BulletShares does have a muni-ETF that would be well suited to that account.
“Bottom Line: you want your highest growing assets in your Roth where they’ll grow tax-free, and your bonds in your IRA where they’ll eventually be taxed as income.”
The above is an absolute myth, as I explain in this article, and others that I have written over the years:
https://seekingalpha.com/article/3979557-myths-concerning-roths-iras-and-rmds
The Bottom Line really is that the one parameter in the equation that tells you which account (Roth or TIRA) will win for you, or your heirs, is the tax rate difference between the two accounts.
I agree the “tax difference between the two accounts” is a key parameter, FD. I also suspect tax rates will be higher in the future than they are now, given the likely 2025 expiration of the current favorable tax brackets for MFJ. Also, once Social Security and RMD’s kick in, my income will be higher in future years, reducing my ability to “play” the tax bracket game for Roth conversions.
Fritz,
I can understand why some people want to build a bond ladder, but what would really be useful is to compare building the same structure using bond funds with the duration(s) equal to the time frame you need the money. It is a bit of an injustice to say those that bought bond funds at time “x” got killed because if they bought a 3-year bond fund then they should not have planned to use it for 3 years in which time they should get exactly what they bought in interest and principal, though the split of interest and principal may be somewhat different. A bond fund is just a bond ladder with a constant duration and inside the bond fund the fund managers are doing much the same thing that you are doing on your own, so why would you expect the results to be much different? It would be very interesting to see someone do a comparison.
Thanks Fritz – Your articles are great: well written, easy to understand and always informative.
I’m trying to prepare for retirement myself and working toward turning an overly aggressive portfolio into something better suited to the bucket strategy. It’s a real work in progress and your advice has been beneficial in helping me along.
I’ve been looking into these BulletShare funds because they sound like they’d fit in well with what I’m trying to do, but I’m really struggling to understand the concept of the YTM figures that are quoted in your article and on the Invesco site.
I understand that investors will receive the NAV (whatever that may be) in December of fund’s year. But as far as I can tell, that will (hopefully) be close to the amount paid up front, so probably no great gains there, right? I’ve seen the calculation on the Invesco site as to how that YTM is calculated, but it’s way over my head. Can you explain (in layman’s terms) how that YTM turns out to actually be several points higher than the quoted dividend yield?
Thanks so much in advance – really appreciate all your insights.
I appreciate your comment that the YTM calculation is “way over your head.” It’s over mine, as well. I’m just trusting the quoted YTM and will be watching closely as the first few rungs mature to see how the math plays out.
I do CDs in my traditional IRA’s, $7500 now that I am “of age” and I realize that is against the advice of Suze Orman to do a traditional IRA and other financial advisors, but it works for me. I have far lower income than you but I also have pretty low expenses. I plan to do RMD’s and I think my age it will actually be required at 75 now under the new rates. I plan to just do shorter term CD’s, in the amount of $6000 a year, for the years 70 to 75 but not in IRA’s. I will be 500 short a month, without the CD, of what my take home is now thet ai am still working so the CD is actually making up for that amount. In other words, with my small pension, social security, plus $500 a month from CD ($6,000 a year) I will equal my take home from this years working take home. I realize this is not accounting for inflation but it is my dumbed down version of not lowering my income too much in retirement.
Simple and easy to understand, Cindy. Seems like a valid approach. I do hope you have some asset allocation dedicated to stocks to allow their higher long-term returns to help offset inflation.
Yes, I buy S&P 500 ETF because I am so not smart about stocks, despite reading about them. I am also so conservative. I buy one share a month, which is usually around $400 to $420 per share. So, I buy roughly just under $6000 a year and on my lower income (I now work part time) that is about all I can afford, between that and 7,500 in IRA CD’s. Combining my retirement income and my part time work income, I am saving one third of my total net including pension every month, which is $1000 of the $3,000 total net income per month.
I realize I made a mistake in explaining my take home in first comment. My net take home is 2 grand a month from my part time job. My pension is 1 grand a month. So total for both is a whopping 3 grand a month… lol. There is no escalation clause with our pensions so it is what it is for the duration. Sorry if it was confusing.
Thanks for walking us through the process of buying the CDs on your brokerage account. What happens when the CD matures? Does it go into the Cash portion of your brokerage account, or is there an automatic rollover (as often happens at the bank or CU) to a new CD at the existing rate that you have a certain amount of time to reverse without penalty?
I have looked at the bullet shares but not sure its really needed since I am not yet retired. Maybe I could start setting some up for when I think I might retire.