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Suppose one does not use laddering: one may invest $30,000 in a five-year bond with a 4% coupon. When the bond matures, prevailing interest rates may have dropped to 2%, making it impossible to achieve the same profit reinvesting in the same type of bond. Had this investor used laddering, he/she would have put, say, $10,000 into three bonds: a five-year bond at 4%, a seven-year bond at 5.5%, and a 10-year bond at 6%. That way, if prevailing interest rates drop to 2% in five years, this only affects the reinvestment of one third of the initial $30,000 investment. This practice is also called staggering maturities or liquidity diversification.
Laddering is an investment strategy that calls for establishing a pattern of rolling maturity dates for a portfolio of fixed-income investments. Your portfolio might include intermediate-term bonds or certificates of deposit (CDs).
For example, instead of buying one $15,000 CD with a three-year term, you buy three $5,000 CDs maturing one year apart. As each CD comes due, you can reinvest the principal to extend the pattern.
Or you could use the money for a preplanned purchase, have it available to take advantage of a new investment opportunity, or use it to cover unexpected expenses.
You can use laddering to pay for college expenses, with a series of zero coupon bonds coming due over four years, in time to pay tuition each year.
And if you ladder, you can avoid having to liquidate a large bond investment if you need just some of the money or to reinvest your entire principal at a time when interest rates may be low.