BOND STRATEGIES
Because bonds come in a variety of maturities, yields, and risk, it is not obvious how to go about creating and managing an investment portfolio.
AAM will review client statements and provide you with suggestions based on your client’s specific financial situation, investment objectives, and risk tolerance.
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Thoughtful portfolio construction begins by considering a number of factors, including the investor’s risk/return profile, cash flow needs, and market expectations. Strategic diversification of a portfolio’s maturity schedule can help better position investors in uncertain interest rate environments. A Bond Ladder, Barbell, and Bullet strategy are three common approaches to constructing a portfolio of individual bonds.
bond ladder strategy
bond ladder strategy
If you are seeking to generate income from your investments, want to preserve your wealth, or planning for a future goal, then a bond ladder strategy may be appropriate.
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Registration does not imply a certain level of skill or training.
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For additional information about the bond strategies discussed herein or to discuss your individual investment situation, please contact your financial professional.
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Click on the strategies below to learn more.
barbell strategy
bullet strategy
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If you are seeking to generate income from your investments, want to preserve your wealth, or planning for a future goal, then a bond ladder strategy may be appropriate.
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If you are seeking to diversify your income and potentially increase risk-adjusted returns, then a bond barbell strategy may be appropriate.
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If you know you will need a certain amount of capital at a given point in time in the future, then a bullet investment strategy might be appropriate.
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Create a predictable income stream by staggering bond maturities
Help minimize interest rate and reinvestment risk
Preserve wealth and plan for the future
Generate incremental yield through appropriate credit exposure
Reasons to consider a bond ladder strategy:
What is a
Bond Ladder?
How It Works
Features of a
Bond Ladder
Risk Considerations
What is a
Bond Ladder?
What is a bond ladder?
A bond ladder is a portfolio of bonds which mature at regular intervals, generally over a period of several years. Money which comes due from maturing bonds is reinvested in bonds with longer maturities at the far end of the portfolio. This process continues year after year as long as an investor’s financial objectives remain the same.
A bond ladder strategy can help to generate a consistent level of income for risk-averse investors seeking first to preserve their accumulated wealth. The strategy can also help investors balance their need for income today with the opportunity to benefit from higher rates later, should they rise.
What is a Bond Ladder?
How It Works
Assuming an initial investment of $100,000, an investor purchases five bonds with staggered maturities extending out every two years. The laddered bond portfolio has a combined average annual yield of 3.42% and an average duration of 6 years.
How It Works
Features of a Bond Ladder
Higher Average Yields
Generally, the longer a bond’s maturity, the higher the yield. A bond ladder combines the higher yields of longer-term bonds with the liquidity of shorter-term bonds. Staggering bond maturities allows investors to earn potentially higher yields than would be possible with short-term investments alone and money market accounts.
Predictable Cash Flows
A bond ladder can be constructed to provide periodic interest payments which can help investors match cash flows with cash expenditure needs. This can be especially beneficial for investors at or nearing retirement.
Manage Interest Rate Risk
By having bonds come due over nearly equal periods of time, you can help smooth out the effects interest rates have on portfolio valuations. How sensitive a portfolio’s valuation is to change in interest rates is known as a portfolio’s duration. A bond ladder can be tailored to target a duration which best fits the investor’s objectives and risk tolerance. Portfolio managers generally seek to reduce a portfolio’s duration to combat the effects rising interest rates can have on a bond portfolio and seek to increase duration to monetize volatility in a declining interest rate environment.
Features of a
Bond Ladder
Risk Considerations
Every investment involves a risk/reward trade-off. As a general rule-of-thumb, the more risk you are willing to take, the higher your return potential, and vice versa. While risk will vary based on the individual bond type, there are two main risks to consider when investing in any type of bond: market risk and credit risk.
Risk Considerations
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
2.05
%
3.00%
3.50%
4.00%
4.50%
5.00%
2-Year
4-Year
6-Year
8-Year
10-Year
2.65
%
3.60
%
4.15
%
4.65
%
Assuming an initial investment of $100,000, an investor purchases five bonds with staggered maturities extending out every two years. The laddered bond portfolio has a combined average annual yield of 3.92% and an average duration of 6 years.
2-Year
4-Year
6-Year
8-Year
10-Year
0.00%
0.50%
2.00%
1.50%
3.00%
2.50%
4.00%
3.50%
5.00%
4.50%
6.00%
2.55
%
%
3.15
%
4.10
%
4.65
5.15
%
Original Ladder
At the end of year two, the shortest bond matures and the four remaining bond investments are now two years closer to their maturity date. Proceeds from the maturing bond are reinvested back into the 10-year bond. The combined average annual yield of the new laddered bond portfolio is 4.55% and the average duration would remain at 6 years.
BOND A
$20,000
BOND B
$20,000
BOND C
$20,000
BOND D
$20,000
BOND E
$20,000
ladder two years later
BOND
MATURED
4-Year
6-Year
8-Year
10-Year
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
0.00
%
%
2.65
%
3.60
%
4.15
4.65
%
BOND A
$20,000
BOND B
$20,000
BOND C
$20,000
BOND D
$20,000
BOND E
$20,000
6.00%
2-Year
5.20
%
ladder two years later
BOND
MATURED
2-Year
4-Year
6-Year
8-Year
10-Year
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
6.00%
0.00
%
3.15
%
4.10
%
4.65
%
5.20
%
5.70
%
BOND A
BOND C
$20,000
BOND D
$20,000
BOND E
$20,000
BOND F
$20,000
Ladder Two Years Later >>
<< ORIGINAL LADDER
This hypothetical example is for illustrative purposes only and does not represent the performance of any specific investment. Bond income is not guaranteed and may be subject to call risk as well as default risk, which increases with lower-rated bond securities.
Mitigate Reinvestment Risk
Reinvestment risk is the risk that when a bond matures, the investor may not be able to reinvest their proceeds in a comparable bond at the same rate. By committing to a bond ladder strategy, investors can lessen the impact reinvestment risk can have on their portfolio. If interest rates rise, your maturing bonds take advantage of improved rates. If interest rates fall, your bond ladder portfolio holdings have the potential to produce more income than could be achieved at the current levels, resulting in a more consistent yield.
Maintain a Degree of Flexibility
With a bond ladder, you’ll have one or more bonds maturing on a regular basis. You can choose to reinvest your principal in another bond or redirect the proceeds for another purpose based on income needs and current investment objectives.
Diversification
A bond ladder strategy allows for a constructive level of diversification. In addition to diversifying your principal in bonds with different maturities, you can also build your bond ladder with different issuers and credit ratings. By diversifying a portfolio’s weighted average credit quality, investors can potentially improve overall yield without incurring unacceptable levels of risk.
Market Risk
The risk that a bond may be worth more or less than what the investor paid, at any point in time, due to changes in interest rates. Bond prices have an inverse relationship with interest rates. Generally, if interest rates are rising, bond investors tend to hold shorter-term bonds because the longer a bond’s time to maturity, the greater its price sensitivity. Conversely, if interest rates are declining, bond investors will typically want to purchase longer-term securities to lock-in a higher yield which may not be available in the future.
It is extremely difficult to accurately determine when interest rates will rise and fall. Maintaining a diversified laddered bond portfolio of short, intermediate, and possibly long-term bonds, and holding them to maturity, may be a good tool to help minimize market risk.
Credit risk
The risk that the issuer of a bond will not make timely interest or principal payments.
Inflation risk
The risk that cash flows will not be worth as much in the future due to inflation. Because bond payouts are generally based on fixed interest rates, increasing inflation will diminish the purchasing power of the investment.
Higher Average Yields
Predicatable Cash Flows
Manage Interest Rate Risk
Mitigate Reinvestment Risk
Maintain a Degree of
Higher Average Yields
Generally, the longer a bond’s maturity, the higher the yield. A bond ladder combines the higher yields of longer-term bonds with the liquidity of shorter-term bonds. Staggering bond maturities allows investors to earn potentially higher yields than would be possible with short-term investments alone and money market accounts.
Predictable Cash Flows
A bond ladder can be constructed to provide periodic interest payments which can help investors match cash flows with cash expenditure needs. This can be especially beneficial for investors at or nearing retirement.
Manage Interest Rate Risk
By having bonds come due over nearly equal periods of time, you can help smooth out the effects interest rates have on portfolio valuations. How sensitive a portfolio’s valuation is to change in interest rates is known as a portfolio’s duration. A bond ladder can be tailored to target a duration which best fits the investor’s objectives and risk tolerance. Portfolio managers generally seek to reduce a portfolio’s duration to combat the effects rising interest rates can have on a bond portfolio and seek to increase duration to monetize volatility in a declining interest rate environment.
Mitigate Reinvestment Risk
Reinvestment risk is the risk that when a bond matures, the investor may not be able to reinvest their proceeds in a comparable bond at the same rate. By committing to a bond ladder strategy, investors can lessen the impact reinvestment risk can have on their portfolio. If interest rates rise, your maturing bonds take advantage of improved rates. If interest rates fall, your bond ladder portfolio holdings have the potential to produce more income than could be achieved at the current levels, resulting in a more consistent yield.
Maintain a Degree of Flexibility
With a bond ladder, you’ll have one or more bonds maturing on a regular basis. You can choose to reinvest your principal in another bond or redirect the proceeds for another purpose based on income needs and current investment objectives.
Diversification
A bond ladder strategy allows for a constructive level of diversification. In addition to diversifying your principal in bonds with different maturities, you can also build your bond ladder with different issuers and credit ratings. By diversifying a portfolio’s weighted average credit quality, investors can potentially improve overall yield without incurring unacceptable levels of risk.
How It Works
How It Works
Assuming an initial investment of $100,000, an investor purchases five bonds with staggered maturities extending out every two years. The laddered bond portfolio has a combined average annual yield of 3.42% and an average duration of 6 years.
2-Year
4-Year
6-Year
8-Year
10-Year
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
2.05
%
%
2.65
%
3.60
%
4.15
4.65
%
Assuming an initial investment of $100,000, an investor purchases five bonds with staggered maturities extending out every two years. The laddered bond portfolio has a combined average annual yield of 3.42% and an average duration of 6 years.
At the end of year two, the shortest bond matures and the four remaining bond investments are now two years closer to their maturity date. Proceeds from the maturing bond are reinvested back into the 10-year bond. The combined average annual yield of the new laddered bond portfolio is 4.05% and the average duration would remain at 6 years.
Original Ladder
2-Year
4-Year
6-Year
8-Year
10-Year
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
2.05
%
%
2.65
%
3.60
%
4.15
4.65
%
BOND A
$20,000
BOND B
$20,000
BOND C
$20,000
BOND D
$20,000
BOND E
$20,000
ladder two years later
BOND
MATURED
2-Year
4-Year
6-Year
8-Year
10-Year
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
6.00%
0.00
%
2.65
%
3.60
%
4.15
%
4.65
%
5.20
%
BOND A
$20,000
BOND B
$20,000
BOND C
$20,000
BOND D
$20,000
BOND E
$20,000
ladder two years later
BOND
MATURED
2-Year
4-Year
6-Year
8-Year
10-Year
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
6.00%
0.00
%
2.65
%
3.60
%
4.15
%
4.65
%
5.20
%
BOND A
$20,000
BOND B
$20,000
BOND C
$20,000
BOND D
$20,000
BOND E
$20,000
Ladder Two Years Later >>
<< ORIGINAL LADDER
This hypothetical example is for illustrative purposes only and does not represent the performance of any specific investment. Bond income is not guaranteed and may be subject to call risk as well as default risk, which increases with lower-rated bond securities.
Features of a
Bond Ladder
Features of a Bond Ladder
Higher Average Yields
Generally, the longer a bond’s maturity, the higher the yield. A bond ladder combines the higher yields of longer-term bonds with the liquidity of shorter-term bonds. Staggering bond maturities allows investors to earn potentially higher yields than would be possible with short-term investments alone and money market accounts.
Predictable Cash Flows
A bond ladder can be constructed to provide periodic interest payments which can help investors match cash flows with cash expenditure needs. This can be especially beneficial for investors at or nearing retirement.
Manage Interest Rate Risk
By having bonds come due over nearly equal periods of time, you can help smooth out the effects interest rates have on portfolio valuations. How sensitive a portfolio’s valuation is to change in interest rates is known as a portfolio’s duration. A bond ladder can be tailored to target a duration which best fits the investor’s objectives and risk tolerance. Portfolio managers generally seek to reduce a portfolio’s duration to combat the effects rising interest rates can have on a bond portfolio and seek to increase duration to monetize volatility in a declining interest rate environment.
Mitigate Reinvestment Risk
Reinvestment risk is the risk that when a bond matures, the investor may not be able to reinvest their proceeds in a comparable bond at the same rate. By committing to a bond ladder strategy, investors can lessen the impact reinvestment risk can have on their portfolio. If interest rates rise, your maturing bonds take advantage of improved rates. If interest rates fall, your bond ladder portfolio holdings have the potential to produce more income than could be achieved at the current levels, resulting in a more consistent yield.
Maintain a Degree of Flexibility
With a bond ladder, you’ll have one or more bonds maturing on a regular basis. You can choose to reinvest your principal in another bond or redirect the proceeds for another purpose based on income needs and current investment objectives.
Diversification
A bond ladder strategy allows for a constructive level of diversification. In addition to diversifying your principal in bonds with different maturities, you can also build your bond ladder with different issuers and credit ratings. By diversifying a portfolio’s weighted average credit quality, investors can potentially improve overall yield without incurring unacceptable levels of risk.
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Ladder Two Years Later
Original Ladder
Ladder
Two Years
Later
Original
Ladder
Inverse Relationship Between Bond Prices and Interest Rates
If Interest Rates Rise
If Interest Rates Fall
It is extremely difficult to accurately determine when interest rates will rise and fall. Maintaining a diversified laddered bond portfolio of short, intermediate, and possibly long-term bonds, and holding them to maturity, may be a good tool to help minimize market risk.
DOWNLOAD BOND LADDER WHITE PAPER
barbell strategy
If you are seeking to diversify your income and potentially increase risk-adjusted returns, then a bond barbell strategy may be appropriate.
Reasons to consider a barbell bond strategy:
Exposure to both short- and long-term yields
Lock-in higher yields associated with longer-term bonds
Maintain liquidity and flexibility with shorter-term bonds
Help mitigate interest rate risk
What is a Barbell?
How It Works
Features of a Barbell
Risk Considerations
What is a bond ladder?
What is a Barbell Strategy?
The barbell structure is a tactical strategy which focuses on purchasing bonds with two different types of maturities – short-term and long-term bonds, leaving out medium-term bonds. This can be helpful because, assuming a normal upward-sloping yield curve, it permits the investor to benefit from the higher coupons which long-term bonds deliver, but also provides a pool of short-term instruments which can be quickly reinvested in higher-yielding securities should interest rates generally rise in the market.
A barbell is considered a more active portfolio strategy as it requires frequent monitoring and action as short-term securities mature and proceeds need to be reinvested.
How It Works
How It Works
Assuming an initial investment of $100,000, an investor purchases five bonds with staggered maturities extending out every two years. The laddered bond portfolio has a combined average annual yield of 3.42% and an average duration of 6 years.
2-Year
4-Year
6-Year
8-Year
10-Year
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
2.05
%
%
2.65
%
3.60
%
4.15
4.65
%
Assuming an initial investment of $100,000, an investor purchases eight bonds, four with shorter-term maturities of 2 years or less, and four with longer-term maturities of 8 years or more. The barbell portfolio has a combined average annual yield of 3.50% and an average duration of 6 years.
0.5-Year
1-Year
1.5-Year
2-Year
8-Year
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
1.30
%
%
1.45
%
1.85
%
2.55
4.65
%
This hypothetical example is for illustrative purposes only and does not represent the performance of any specific investment. Bond income is not guaranteed and may be subject to call risk as well as default risk, which increases with lower-rated bond securities.
Features of a Bond Barbell
Lock-in Yield
Generally, the longer a bond’s maturity, the higher the yield. A barbell strategy combines the higher yields of longer-term bonds with the liquidity of shorter-term bonds. Balancing between bonds with short and long maturities allows investors to potentially earn higher yields than would be possible with short-term investments alone and money market accounts. Additionally, you will know what yield you will be earning over a longer time period.
Mitigate Interest Rate Risk
Having bonds come due in both the short- and long-term allows you to tactfully manage the effects interest rates can have on a portfolio. If interest rates are high, longer-term bonds allow investors to lock-in higher rates over a long period of time. In a falling interest rate environment, the ability to hold on to these higher-yielding bonds can enhance the overall yield of the portfolio. In a rising interest rate environment, investors have the opportunity to reinvest the proceeds of the shorter-term securities at higher rates.
Maintain a Degree of Flexibility
Implementing a barbell strategy allows investors to strategically structure new purchases and adjust duration targets based on current income needs and risk tolerance. Because short-term bonds mature frequently, they provide the liquidity and flexibility to reinvest principal in another bond or redirect the proceeds for another purpose based on your current income needs and investment objectives.
Diversification
A bond barbell strategy allows for a constructive level of diversification. In addition to diversifying your principal in bonds with short and long maturities, you can also structure your portfolio with different issuers and credit ratings. By diversifying a portfolio’s weighted average credit quality, investors can potentially improve overall yield without incurring unacceptable levels of risk.
Next Page
Next Page
Mitigate Reinvestment Risk
Reinvestment risk is the risk that when a bond matures, the investor may not be able to reinvest their proceeds in a comparable bond at the same rate. By committing to a bond ladder strategy, investors can lessen the impact reinvestment risk can have on their portfolio. If interest rates rise, your maturing bonds take advantage of improved rates. If interest rates fall, your bond ladder portfolio holdings have the potential to produce more income than could be achieved at the current levels, resulting in a more consistent yield.
Maintain a Degree of Flexibility
With a bond ladder, you’ll have one or more bonds maturing on a regular basis. You can choose to reinvest your principal in another bond or redirect the proceeds for another purpose based on income needs and current investment objectives.
Diversification
A bond ladder strategy allows for a constructive level of diversification. In addition to diversifying your principal in bonds with different maturities, you can also build your bond ladder with different issuers and credit ratings. By diversifying a portfolio’s weighted average credit quality, investors can potentially improve overall yield without incurring unacceptable levels of risk.
Previous Page
Risk Considerations
Risk Considerations
Every investment involves a risk/reward trade-off. As a general rule-of-thumb, the more risk you are willing to take, the higher your return potential, and vice versa. Risks will vary based on the individual bond type.
Reinvestment Risk
Reinvestment risk is the risk that when a bond matures, the investor may not be able to reinvest their proceeds in a comparable bond at the same rate. When short-term bonds come due, it is unknown at what rate proceeds can be reinvested.
the greater its price sensitivity. Conversely, if interest rates are declining, bond investors will typically want to purchase longer-term securities to lock-in a higher yield which may not be available in the future.
It is extremely difficult to accurately determine when interest rates will rise and fall. However, longer-term bonds carry higher interest rate risk than short-term bonds.
Inverse Relationship Between Bond Prices and Interest Rates
If Interest Rates Rise
If Interest Rates Fall
Credit risk
The risk that the issuer of a bond will not make timely interest or principal payments.
Inflation risk
The risk that cash flows will not be worth as much in the future due to inflation. Because bond payouts are generally based on fixed interest rates, increasing inflation will diminish the purchasing power of the investment.
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What is a Barbell?
TYPES OF BARBELL STRATEGIES
The barbell strategy is an investment concept which attempts to strike a balance between risk and reward by investing in the two extremes of lower-risk and higher-risk assets, avoiding middle-of-the-road choices. While we describe a barbell strategy as being comprised of short- and long-term bonds, the strategy can be implemented in other ways.
A barbell strategy can be structured to include high-rated, investment-grade bonds combined with non-investment grade, high yield bonds.
Credit
How sensitive a portfolio’s valuation is to change in interest rates is known as a portfolio’s duration. A barbell strategy can be tailored to target bonds with short and long durations. Shorter duration bonds help combat the effects rising interest rates while longer duration bonds may help to monetize volatility in a declining interest rate environment.
Duration
A barbell strategy can be a mix of investment types, such as stocks and bonds.
Mixed Product
6.00%
9-Year
12-Year
14-Year
5.15
%
5.40
%
5.65
%
Four bonds with shorter-term maturities of 2 years or less
Four bonds with longer-term maturities of 8 years or more
Features of a Barbell
Market Risk
The risk that a bond may be worth more or less than what the investor paid, at any point in time, due to changes in interest rates. Bond prices have an inverse relationship with interest rates. Generally, if interest rates are rising, bond investors tend to hold shorter-term bonds because the longer a bond’s time to maturity, the greater its price sensitivity. Conversely, if interest rates are declining, bond investors will typically want to purchase longer-term securities to lock-in a higher yield which may not be available in the future.
It is extremely difficult to accurately determine when interest rates will rise and fall. However, longer-term bonds carry higher interest rate risk than short-term bonds.
bullet strategy
If you know you will need a certain amount of capital at a given point in time in the future, then a bullet investment strategy might be appropriate.
Reasons to consider a bullet bond strategy:
Plan for capital event in the future
Attractive strategy in a rising interest rate environment
Lower initial investment requirements
Help mitigate interest rate risk
What is a Bullet?
How It Works
Features of a Bullet
Risk Considerations
What is a Bullet?
What is a bond ladder?
What is a Bullet Strategy?
In a bullet strategy, the investor only purchases bonds which mature on or near a certain date, usually so that principal re-payment coincides with an anticipated need for funds. Generally, the investor will purchase assets over an extended period of time, in an effort to take advantage of market opportunities, as well as to diversify their bond holdings. If interest rates rise between bond purchases, the investor may be able to earn a higher rate of return. If interest rates fall, the investor would earn a lower rate of return.
How It Works
How It Works
Assuming an initial investment of $100,000, an investor purchases five bonds with staggered maturities extending out every two years. The laddered bond portfolio has a combined average annual yield of 3.42% and an average duration of 6 years.
As an example, an investor is saving for their son to go to college in 8 years. They want the bonds in their portfolio to mature at the same time, coinciding with this event. To help reduce exposure to fluctuating interest rates, which are generally associated with longer-term bonds as they are more likely to lose value when rates rise, the investor decides to stagger bond purchases over a 4-year period.
In this example, the final bullet portfolio has a combined average annual yield of 5.10%.
0.5-Year
1-Year
1.5-Year
2-Year
8-Year
9-Year
12-Year
14-Year
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
6.00%
0.80
%
0.95
%
1.35
%
2.05
%
4.15
%
4.65
%
4.90
%
5.15
%
Four bonds with shorter-term maturities of 2 years or less
Four bonds with longer-term maturities of 8 years or more
This hypothetical example is for illustrative purposes only and does not represent the performance of any specific investment. Bond income is not guaranteed and may be subject to call risk as well as default risk, which increases with lower-rated bond securities.
Features of a Bullet
Features of a Bond Bullet
Plan for a Future Event
The bullet strategy is generally employed when an investor has a future liability for which they are planning, such as a down payment, child’s college tuition, or retirement. When the portfolio matures, the investor ensures they have the funds to meet their financial needs.
Lower Initial Investment Requirements
Successfully executing a bullet portfolio strategy generally requires a lower initial investment while seeking to invest in progressively higher yields as the portfolio is built over time. The strategy assumes the investor does not have cash sitting on the sidelines, but rather they are investing gradually as funds become available.
Higher Potential Yield
Generally, the longer a bond’s maturity, the higher the yield. A bullet strategy generally invests in longer-term bonds with higher yields over a period of time. If interest rates rise between bond purchases, the investor may be able to earn a higher rate of return. If interest rates fall, the investor would earn a lower rate of return.
Diversification
By purchasing bonds at different times, a bullet strategy aims to reduce the impact of interest rate fluctuations. Portfolios can also be structured with different issuers and credit ratings. By diversifying a portfolio’s weighted average credit quality, investors can potentially improve overall yield without incurring unacceptable levels of risk.
Next Page
Next Page
Mitigate Reinvestment Risk
Reinvestment risk is the risk that when a bond matures, the investor may not be able to reinvest their proceeds in a comparable bond at the same rate. By committing to a bond ladder strategy, investors can lessen the impact reinvestment risk can have on their portfolio. If interest rates rise, your maturing bonds take advantage of improved rates. If interest rates fall, your bond ladder portfolio holdings have the potential to produce more income than could be achieved at the current levels, resulting in a more consistent yield.
Maintain a Degree of Flexibility
With a bond ladder, you’ll have one or more bonds maturing on a regular basis. You can choose to reinvest your principal in another bond or redirect the proceeds for another purpose based on income needs and current investment objectives.
Diversification
A bond ladder strategy allows for a constructive level of diversification. In addition to diversifying your principal in bonds with different maturities, you can also build your bond ladder with different issuers and credit ratings. By diversifying a portfolio’s weighted average credit quality, investors can potentially improve overall yield without incurring unacceptable levels of risk.
Previous Page
Risk Considerations
Risk Considerations
Inverse Relationship Between Bond Prices and Interest Rates
If Interest Rates Rise
If Interest Rates Fall
Credit risk
The risk that the issuer of a bond will not make timely interest or principal payments.
Limited Diversification
A bullet strategy is designed to build diversification over time, which means it has limited diversification at the beginning. Additionally, the investor is overexposed to one part of the yield curve as a result of the strategy.
Inflation risk
The risk that cash flows will not be worth as much in the future due to inflation. Because bond payouts are generally based on fixed interest rates, increasing inflation will diminish the purchasing power of the investment.
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1-Year
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
year
1
2
3
4
5
6
7
8
years to Maturity
8 years
6 Years
5 Years
3 years
Bond Yield
4.55%
4.80%
5.65%
5.40%
6.00%
2-Year
3-Year
4-Year
5-Year
6-Year
7-Year
8-Year
9-Year
10-Year
Market Risk
The risk that a bond may be worth more or less than what the investor paid, at any point in time, due to changes in interest rates. Bond prices have an inverse relationship with interest rates. Generally, if interest rates are rising, bond investors tend to hold shorter-term bonds because the longer a bond’s time to maturity, the greater its price sensitivity. Conversely, if interest rates are declining, bond investors will typically want to purchase longer-term securities to lock-in a higher yield which may not be available in the future.
It is extremely difficult to accurately determine when interest rates will rise and fall. However, longer-term bonds carry higher interest rate risk than short-term bonds.
These bond strategies may not be appropriate for all investors. This report is for informational purposes only, does not pertain to any security product or service, and is not an offer or solicitation of an offer to buy or sell any product or service. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her advisors.
Unless otherwise stated, all information and opinion contained in this publication were produced by Advisors Asset Management, Inc. (AAM) and other sources believed by AAM to be accurate and reliable. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources may be required to make informed investment decisions based on your individual investment objectives and suitability specifications. Any expression of opinion is subject to change without notice.
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BOND B
$20,000
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