(MoneyWatch) We often hear criticism from the financial media and some professional advisors about the use of “bond ladders.” For example, columnist Jane Bryant Quinn took ladders to task in her column “7 Reasons Why Bond Ladders are Bad for Investors.” Unfortunately, much of the criticism is based on falsehoods and the conflicts of interests from advisors who only use mutual funds and ETFs. To correct such misperceptions, we’ll address each of the criticisms raised, beginning with the issue of credit risk.
Before we get started, here’s a quick note about what exactly a bond ladder is. Building a bond ladder involves buying individual bonds with increasingly long maturities. For instance, you might have a ladder than owns bonds that mature each year for the next 10 years. Proceeds from maturities and interest can be used to continue to build the ladder.
Credit risk and the need for diversification
It’s true that the greatest benefit of mutual funds is diversification, which is critical for investments that have lots of idiosyncratic risks, like stocks and junk bonds. However, with Treasury bonds and FDIC insured CDs, there’s no need to diversify because there isn’t any credit risk.