How to Ladder Your Retirement Savings

Laddering your portfolio can help protect your nest egg.

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Ladders are an excellent way for the do-it-yourself retirement investor to manage risk while seeking above average returns. When an investment or asset class is laddered, units of the investment are deliberately purchased at different times or with different maturities. This can create a group of the same investments in which risks of ownership are reduced. Here are three conservative asset classes that you can ladder as part of a retirement portfolio.

Treasury ladders. Treasury Inflation Protected Securities (TIPS) are government bonds that provide inflation protection by adjusting the bond principal based on changes in the cost of living Index. Because TIPS are traded on the secondary market, their market value can change inversely with changes in interest rates. This is risky if most of the TIPS you own have the same maturity. Even if you intend to hold your TIPS to maturity, you do not want to limit your holdings to similar bonds having low interest rates. TIPS laddering is a good strategy to reduce both of these risks.

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It is easy to build a ladder of short or medium term Treasury Bills. It is harder to ladder TIPS because they are sold with maturities of 5, 10, or 30 years. For a proper bond ladder, you want a shorter time interval between steps. Therefore, to create a three-year Treasury Ladder (maturing at 1, 2, and 3 years) using TIPS, you would need to buy at least some of the TIPS in the secondary market.

You can buy TIPS on the secondary market through a broker but you must be careful about pricing and fees. After you build the initial ladder, you can replace TIPS in your ladder that mature by purchasing them directly at a Treasury auction.

Another investing strategy that is similar to a Treasury ladder is purchasing shares of exchange traded funds that invest in Treasury Bonds and TIPS having different maturities. Examples include the iShares Barclays Short Treasury Bond ETF, the iShares Barclays 1-3 year Treasury Bond ETF, and the iShares Barclays TIPS ETF. While ETF laddering does not produce an optimal maturity profile, it is easier to implement than buying TIPS in the secondary market.

TIPS should be owned in a tax-deferred account so that you are not immediately taxed on the virtual income arising from the periodic inflation adjustments.

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Annuity ladders. If you can tolerate the expenses, fixed annuities can provide a predictable lifetime income, but not without risks. These risks include fluctuations in returns offered for new products from year to year and risks that the insurance company behind the annuity might fail.

An annuity ladder can spread and perhaps minimize these risks by using multiple annuity products purchased at different times. Assume that you are age 65 and are willing to invest $300,000 into an immediate annuity. Your annuity purchase today, with no survivor benefits, would probably earn you a fixed monthly income for life in the range of $2,000.

The laddering strategy assumes that you are willing to draw more income from retirement savings now so that you can purchase a ladder of smaller annuities. You can buy an immediate annuity at age 65 for $100,000 and receive $650 a month. At age 70, you purchase a second $100,000 annuity and receive another $750 a month. At age 75, you buy a third $100,000 annuity to receive another $900 in monthly income. This increases your combined monthly annuity income to $2,300 in today’s dollars.

If you ladder annuities by delaying the purchase, you obviously are foregoing annuity income in the early years compared to a non-laddered strategy. The trade-off is that you are able to invest the other cash in the market. Using laddering may allow you to come out ahead in the overall size of your retirement portfolio and income. Also, by purchasing the laddered annuities from different companies, you reduce the risk of a single company going bankrupt.

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CD ladders. You can construct a CD ladder by using a lump sum to purchase multiple certificates of deposit having different maturity dates. This may provide a predictable cash flow. The laddered CDs with different maturity dates allow you to take advantage of favorable interest rates in the future without having money locked in at one rate. When one CD matures, you may reinvest the principal to maintain the ladder.

Many investors who build CD ladders tend to purchase all of their laddered CDs from one bank. That may not be the way to get optimal interest rates for each CD in the ladder. Instead, expand your search at renewal time to include multiple financial institutions, even those in other states. If they are FDIC insured, you have little to worry about.

Mark Patterson is an engineer, patent attorney, baby boomer, and author of The Failsafe Retirement System. He blogs on matters of personal finance and retirement planning at Tough Money Love and Go To Retirement.