Investing: Tips for building your staggered-maturity bond ladder
Blackrock recently launched a suite of exchange-traded funds that make it easy to invest in inflation-protected Treasury securities (government bonds that move in step with inflation and pay a fixed coupon rate on top) of different maturities.
All of the 10 new iShares iBonds ETFs — so-called target-maturity funds — come due in different years and sport target dates that range between 2024 and 2033. Target-maturity ETFs aren’t new; Blackrock and Invesco started offering them nearly a decade ago. But the earlier versions focus on corporate, municipal or Treasury bonds, which don’t adjust with inflation.
By eliminating the hassles of buying individual bonds, these ETFs make it easy to build a bond ladder, which involves spreading your investments among bonds with staggered maturities — the ladder “rungs.” The goal is to provide steady income or minimize interest rate risk (bond prices and interest rates move in opposite directions).
As bonds mature, you reinvest the proceeds in a rung further up the maturity line, spend the cash or invest it elsewhere.
Inflation-protected securities work differently than traditional Treasuries. The principal, or face value, of TIPS, which are issued with five-, 10- and 30-year maturities, rises or falls monthly in step with the consumer price index.
On top of that, TIPS pay a fixed rate of interest, or coupon rate, every six months.
Target-maturity funds need some explaining too. The iShares iBonds Oct
2024 Term TIPS ETF (symbol IBIA), for example, holds TIPS that come due between January 2024 and mid-October 2024. Interest payouts are made quarterly. As the portfolio’s bonds mature, the proceeds are reinvested into October-dated bonds or held in a money market fund within the ETF. On October 15, the ETF will officially close and return all of the capital to shareholders.
It’s best to buy and hold these funds to maturity. Each of the 10 funds charges a 0.10% expense ratio, and all sport a yield of at least 6% or better. But those yields include both interest income and inflation adjustments to the principal. Blackrock likes to say these investments “mature like a bond and trade like a stock.”
You can buy shares in the ETFs for as little as the price of one share or less if your broker offers fractional-share purchases. That’s less than the $1,000 minimum to buy Treasuries on most broker platforms, as well as the $100 minimum outlay required to buy the securities directly from TreasuryDirect.gov. And you can reinvest your interest income and buy more shares in the ETF.
“I’m a fan of TIPS ladders. And if you like TIPS ladders, you’ll like these funds,” says Morningstar’s John Rekenthaler.
Whether you hold TIPS directly or invest through an ETF, the tax implications are the same: Interest payments are exempt from state and local taxes, but you’ll owe federal income tax on interest income and inflation adjustments to the principal — due in the tax year they occur, even if you don’t sell the bond — if you hold these assets in a taxable account.