Laddering is a strategy investors can use in a variety of asset classes. Laddering is structuring a number of similar assets with differing time periods or maturity dates. In my opinion laddering is best explained by using Certificates of Deposits (CD) that you would get from a bank.
To ladder a group of CDs, an investor would buy a group of CDs with differing maturities. Typical lengths of CDs are 21 days, 1 month, 3 months, 6 month, 7 months, 9 months, 1 year, 2 year, 3 year, 5 year, and 10 years. There are 11 CDs above with 11 different maturity dates.
An example would be to buy one CD of each length above. This would mean the investor would have a CD coming due according to the maturity dates above. This accomplishes two things. It means the investor would have cash due him when each CD matures, continually making cash available for up to 10 years with 11 dates in total had the investor bought all the CDs listed. Of course not all 11 have to be bought. An investor could buy as many or as few as he desired. In addition to having an amount available at every maturity date, the investor would get a different amount of interest paid to him with each CD. The longer dated ones would usually pay a higher amount with the shorter duration paying less. This is not always the case such as when the yield curve inverts, an event typified by shorter maturity dated CDs paying more than longer dated ones but that occurrence is rare and is a story for another day.
Although the longer dated CDs pay more interest, they are more susceptible to movement in the economy’s general interest level. Since your interest rate on a CD purchased is locked until the maturity, when rates rise for example, you can buy the higher interest rate CDs when each of your CDs matures. If interest rates fall however, you longer maturity CDs would look more attractive, as the higher rates they pay are locked in.
Laddering can also be used on annuities. In this case, an investor would buy a handful of annuities with different payment conditions, different maturity dates and perhaps even differing “gearing” to an underlying index. In other words the investor buys a handful of different annuities. Since annuities come in a variety of structures and there are literally hundreds available, selecting a few different ones might provide an additional level of performance based on what happens in the markets.
Although how one sets up a ladder on whatever asset class they choose will take some knowledge, your investment advisor or some time spent in researching what is available and how laddering works might go a long way in accomplishing better diversification in your portfolio.
Laddering can also be used on a variety of what is called fixed income investments such as individual bonds, mortgages and other types of debt instruments. In simple terms, buying a variety of time sensitive investments with different maturities and conditions might be preferred over owning a lot of just one thing.
Laddering may not necessarily prevent losses. This is not a recommendation to buy or sell any securities. Investing involves risk depending on the type of investment. Consult with a financial professional before making any investment decisions and do your own research before investing.
This article expresses the opinions of Marc Cuniberti and are opinions only and should not be construed or acted upon as individual investment advice. Mr. Cuniberti is an Investment Advisor Representative through Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Marc can be contacted at SMC Wealth Management, 164 Maple St #1, Auburn, CA 95603 (530) 559-1214. SMC and Cambridge are not affiliated. His website is www.moneymanagementradio.com. California Insurance License # OL34249