I recently received the following question from a reader:

Could you elaborate a bit more into your investment philosophy on fixed income? You mention that someone drawing fixed income should have 5-7 years worth of income invested in a fixed income ladder. Does this mean that as the year 1 bond matures, the investor should use the principal and interest from the other 7 years worth of bonds for retirement income? Do you automatically buy another 7-year bond once the 1-year bond matures? Do you sell equities or use the dividend to buy the 7-year bond? Even if the market is down for the year? Should an investor that is not all that close to retirement still have a fixed income ladder? If not, should they have any allocation to fixed income? Thank you for taking the time to read my questions, and I really enjoy reading the articles.

Thank you for your question and your readership! I would be happy to elaborate.

A stability allocation has two purposes: to meet withdrawal needs and to move the portfolio more conservative (less risky) by dampening the volatility of stock returns.

If you are not anticipating withdrawing from any of your investment accounts over the next 7 years, then you do not need a bond allocation. Some people want a bond allocation anyway because of their risk tolerance.

That being said, if you are behind on your savings goals for your ideal retirement, you may not be able to afford to move more conservative as the additional risk/return from large stock allocations may be your best bet of meeting your retirement goals. However, if you are ahead of your savings goals, you may be able to afford to move more conservative in your asset allocation.

As you are describing, if you are creating a laddered bond strategy using individual bonds, you would periodically purchase 6- or 7-year individual bonds which would mature in the year in which the money is needed for spending.

Although you can implement a bond ladder using individual bonds this way, we elect to implement a bond laddering strategy using exchange-traded funds (ETFs) as it is simpler, more flexible, and more diversified.

An ETF-crafted bond ladder works by allocating 6- or 7-years of spending across all your chosen bond funds. Then when it comes time to withdraw, you sell whatever is necessary to rebalance the account.

If your target top level asset allocation is 25% to bonds and 75% to stocks, but your accounts have drifted to 20% bonds and 80% stocks due to market appreciation, you would sell stocks to meet your withdrawal needs. This would also rebalance your account’s asset allocation. If due to market depreciation the account drifted the other way to 30% bonds and 70% stocks, then you would sell bonds to meet your withdrawal needs and rebalance the account. Therefore, you withdraw from bonds when stocks are down, avoiding the danger of depleting your stock portfolio by excessively withdrawing from it while it is down.

In this way, you always have bonds in your portfolio to provide the desired stability in your account. Regardless of whether you withdraw more, less, or exactly what you expected, you can simply rebalance when it comes time to withdraw.

This strategy simplifies adding stability to a portfolio and frees up your ability to make more strategic decisions like which bond funds you’d like to use to represent your stability allocation.

​​In our most simple asset allocation (our free Marotta’s Gone-Fishing Portfolios), we currently represent the bond allocation using 60% the U.S. aggregate bond fund Schwab U.S. Aggregate Bond ETF (SCHZ) and 40% the emerging markets foreign bond fund Vanguard Emerging Markets Government Bond ETF (VWOB).

A few years ago, we also explained a more complex bond strategy in “Bond Investing In 2016” where we wrote:

Here is a good example: keep six months of safe spending in cash, and the next six years of spending invested in these five funds as follows:

• 1 year invested in the Schwab Short Term US Treasury ETF (SCHO). This money won’t need to be used for half a year.
• 2 years invested in the Schwab US Aggregate Bonds ETF (SCHZ). This won’t be needed for a year and a half.
• 0.6 years invested in the Schwab US TIPS ETF (SCHP). This won’t be needed for 3.5 years.
• 0.7 years invested in the Vanguard Total International Bond Index ETF (BNDX). This won’t be needed for 4.1 years.
• 1.7 years invested in the Vanguard Emerging Market Government Bond ETF (VWOB). This won’t be needed for 4.8 years.

If you are interested in these types of topics, you may enjoy reading more about Asset Allocation design here.

If you are looking for extra help in getting started with investing, you may benefit from either our free Marotta’s Gone-Fishing Portfolios, our low-cost “Do-It-Yourself” service level, or our full-service comprehensive wealth management.

Also, we often select new article topics from the Contact Form requests we receive. If you feel you have a case or a question that is not answered or addressed by articles previously written, you can try asking your questions of us and see if we respond. We cannot guarantee that we will answer your question, but you are always permitted to ask.

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