I’ve heard of CD ladders to earn more money on my savings, but what about bond ladders? A financial planner explains.

Maggie Klokkenga, CPA, CFP®, AFC.

A few months ago one of my money nerd friends mentioned that Wealthfront had an automated bond ladder. While I am familiar with CD laddering — and currently have a CD ladder with Ally — the concept of a bond ladder was new to me.

Curious about whether a bond ladder is worth exploring, I asked Maggie Klokkenga, a CPA, CFP®, and AFC® with the advice-only financial planning firm Abundo Wealth, for her insights on bond ladders and what to consider before creating one.

What is a bond ladder?

A bond is a debt instrument with a maturity date. To break it down, bond maturity dates are usually categorized into three main camps: short-term (1 to 3 years), medium-term (4 to 10 years), and long-term bonds (longer than 10 years).

A bond ladder is essentially a portfolio of individual bonds. You have one bond at a time maturing at a certain cadence, such as every month, every quarter, or every year. It can be made up of different types of bonds, such as corporate bonds, municipal bonds, and US Treasuries.

You might create a bond ladder to lock in a favorable interest rate being offered right now. Once that bond matures, you can either reinvest the bond or take out the funds.

If you close a bond early, you likely only receive interest up to the date of the sale, or you may lose several months of interest or some of the principal, depending on the type of bond. Each bond has different rules, so how much interest you lose could depend on when you cash it out. You might even be on the hook to pay a commission for the transaction.

How to use a bond ladder

Klokkenga offers the following example: Let’s say you create a bond ladder and each rung matures every three months or six months. “Once that bond matures, you’ve now got that pot of money,” Klokkenga says. “And it’s earned some interest along the way.” Plus, because you’ve locked in a rate, those interest earnings are guaranteed.

You can use that money as a source of income for retirement. For instance, you can create a bond ladder with one-year staggered maturity dates in your retirement portfolio. That way, when you retire, you can access a portion of those funds each year and use them as part of your income.

Another example? You just bought a fixer-upper house, and you’ve got several home improvement projects you want to fund. “Even if you’re not sure the exact dollar amount you need for the future, just think of them as pots of money you can tap into at a regular cadence,” Klokkenga says.

“It’s like mental accounting,” she says. “You say, ‘This bond is going to be for the bathroom. This bond is going to be for the kitchen. This one’s going to be for the living room.’ And when that bond matures, you have that money. Similarly, if you’re in retirement and looking to create a paycheck, this is the first part of creating the paycheck.”

Build a bond ladder before interest rates fall

Now that the Fed has begun cutting interest rates, people might be jumping on the bond ladder bandwagon. “Once the rates start to decrease, if you’re in a bond ladder, that’s great because you’ve already locked in those rates,” Klokkenga says. “Now is the time to create that bond ladder to lock in higher interest rates.”

“And if interest rates are really good right now, and you know you’re going to need some money later on, it’s a way of ‘no touching,'” Klokkenga says. “You can’t touch it right now because it’s typically locked up in that bond.”

Where to set up a bond ladder

Wealthfront is the only financial platform that offers an automated bond ladder. Once a bond matures, Wealthfront will reinvest the proceeds from the bond into another bond, extending the rung in your ladder by a month.

You choose the length of the ladder, and Wealthfront will distribute the funds evenly across all the rungs of the ladder. Wealthfront will analyze which bonds to invest in. However, it invests primarily in US Treasuries.

You’ll need a minimum deposit of $500 to get started, and the investment service platform charges its standard annual advisory fee of 0.25% annual management fee. So if you invest $10,000 across all your rungs in a bond ladder, the annual fee is $250.

If you’re not sure when you need the money, don’t automate, recommends Klokkenga. “Invest in bonds with shorter-term maturities or just keep in a high-yield savings account.”

Besides Wealthfront’s automated bond ladder, you can create a bond ladder through online brokers Fidelity and Charles Schwab, explains Klokkenga. They each have a bond ladder tool to help you build your own.

Another option to consider is to create a bond ladder through iShares. iShares has something called iBonds ETFs, which mature like a bond but can be traded like a stock. iShares’ expense ratio is 10 basis points or 0.10%. So if you invest $10,000 in a bond ladder, the fee is $100.

A few tips for bond ladders

Avoid callable bonds

If you buy a bond that’s callable, the issuer (i.e. the government or a corporation) can call the bond and redeem it before it reaches the maturity date. You don’t want to pick a callable bond because it messes up the rungs in your ladder.

Don’t use a bond ladder for an emergency fund

One thing you don’t want to do with a bond ladder is to park funds for emergency savings, Klokkenga says. That’s because you need to easily access the money in your savings. Instead, create a separate high-yield savings account and save your money there.

Start with a short-term ladder

If you’re not entirely confident about creating a bond ladder, start with a short-term one, Klokkenga says.”If you’re afraid to try it out, you don’t want to lock your money up too long, or you just want to see how it goes,” she says, “try a three-month commitment, and do three bonds over three months.”