Some people say a good way to manage a fixed income portfolio when interest rates are uncertain is to ladder bonds.  Others claim that individual bonds will not generate extra income when interest rates go up and that bond mutual funds are a better bet.

Laddering bonds is defined by investing in bonds with different maturity dates. The claim is that you can invest in bonds and lower your risk in the market. As your bonds mature, the idea is to re-invest your money into new bonds at the prevailing rates, thus keeping yourself constantly in the game, rather than waiting on long-term funds to mature. 

Here are some pros and cons: 

PROS

• A bond ladder will match cash flows with a demand for cash.  It can reduce the risk of putting all of your eggs in one basket and instead provides returns throughout the year. One bond might mature in one year, the next in two years, etc. This is how you build “rungs” on your ladder.

• By staggering returns, you aren’t locked into one particular bond that might not provide the return you want in the long run. If you invest $10,000 into one single bond with a yield of 5% for a term of 10 years, you won’t be able to capitalize on increasing or decreasing interest rates during this period.

• Using a bond ladder helps you to survive the market fluctuations because you have a different bond maturing  (about) every year. If you have a bond that matures at the bottom of the interest rate, you have a chance to improve your yield at a much quicker pace.

• Your cash flow is fluid. This can especially be good for retirees who depend on investments as the main source of income. If you lose your job or have an unexpected expense, the upcoming source of income can be reassuring.

• The greater the number of rungs (bonds) on your ladder, the more diversified your portfolio can be and will help if any one company defaults on their bond payments. The higher you take your ladder, your average returns could be higher since bond yields generally increase with time.

CONS

• Investing in individual bonds pays at a fixed rate. What if that rate is lower in the marketplace when it comes to maturity? You could lose out. In contrast, a bond mutual fund can add higher rate bonds into the pool to ensure interest income.

• You could be forced to reinvest at lower rates with an individual bond if you do not chose to spend the money. In a bond mutual fund, if interest rates decline, the value of your bond fund shares will rise, giving you more shares than you started with, and more potential gains. 

• Bond ladders can have a higher default risk. If one goes bad, it could take a mean slice out of your portfolio. Mutual funds are more diversified.

• Bond ladders can be expensive. They need to be managed, meaning more commissions. A no-load mutual fund charges no commissions and costs only a small amount per year in management fees. 

• The money needed to start a ladder that would have at least five rungs is usually a large investment. You may want to avoid building a ladder altogether if you can’t afford a portfolio that invests in both stocks and bonds for diversity.