Individual Bonds Without Laddering

A handful of individual bonds maturing in the same year is not diversification; it is a bet that interest rates will be favorable when you need to reinvest.

Some investors prefer individual bonds to bond funds, attracted by the simplicity of holding to maturity and receiving their principal back. This is a reasonable preference—no fund manager, no NAV fluctuations, no tax drag from internal trading. But individual bonds carry a hidden risk that is often overlooked: reinvestment risk. When a bond matures and you receive your principal, you must reinvest that capital. If you have multiple bonds all maturing in the same year or within a few years, you are concentrating your reinvestment into a narrow time window. If interest rates are low when your bonds mature, you have no choice but to reinvest at low rates.

Key takeaways

• Individual bonds held to maturity eliminate interest-rate risk but introduce reinvestment risk.
• Reinvestment risk: if many bonds mature when rates are low, you are forced to reinvest at unfavorable yields.
• A bond ladder spreads maturities across multiple years, reducing the concentration of reinvestment timing.
• Most retail investors with under $500,000 in bonds should use bond funds instead of ladders; the effort-to-benefit ratio is poor.
• If you do build a ladder, use Treasury bonds or high-quality corporate bonds, not junk or speculative credits.

What is reinvestment risk?

Suppose you buy a 10-year Treasury bond yielding 4% in 2024. The bond is stable; you receive $40 annually, and in 2034, you receive your $1,000 principal back. Meanwhile, each annual coupon of $40 must be reinvested. Where do you reinvest it? If rates have fallen to 2% by 2025, you reinvest at 2%. If rates rise to 6% by 2030, you reinvest at 6%. Over the 10-year holding period, your realized return depends not just on the 4% coupon from the original bond, but on the varying reinvestment rates for those coupons.

This is reinvestment risk: the uncertainty about the rates at which you will reinvest interim cash flows. It is invisible if you think only about the original bond, but it is real. A bond's stated yield-to-maturity (YTM) of 4% assumes that coupons are reinvested at 4%. If you actually reinvest at lower rates, your realized return falls below 4%.

The maturity concentration trap

Consider an investor who owns five individual bonds:

1. $10,000 IBM bond, maturing 2028
2. $10,000 AT&T bond, maturing 2029
3. $10,000 Exxon bond, maturing 2030
4. $10,000 Microsoft bond, maturing 2031
5. $10,000 General Electric bond, maturing 2032

This looks diversified across companies. But maturity-wise, the investor is not diversified. In each year from 2028 to 2032, $10,000 matures. The investor must then decide what to do with that capital. If 2028–2032 coincide with a period of historically low interest rates (say, 2–2.5%), the investor is forced to reinvest at bad rates every single year. If rates spike to 5% just after 2032, the investor has missed the window entirely.

Conversely, an investor with a ladder has better optionality. If bonds maturing in 2028 can be reinvested into 2038 bonds at 4%, and bonds maturing in 2032 can be reinvested into 2042 bonds at 3.5%, the investor has taken advantage of the rate structure as it exists at each reinvestment date, not all at once.

Historical example: the 1990s yield-down period

In the early 1990s, 10-year Treasury bonds yielded 6–7%. An investor might have bought a ladder of 10-year bonds at these high yields, expecting to lock them in. But as the 1990s progressed, yields fell. By 1997, 10-year Treasuries yielded 5%. By 2001, they yielded 3%. An investor with a non-laddered portfolio might have held a 1991 bond maturity date of 2001, and in 2001, with $100,000 principal returning, faced reinvestment at 3%. Conversely, an investor with a ladder had bonds maturing every year. In 1993, when rates were still relatively high, they reinvested. In 1997, when rates were lower, they reinvested. In 2001, they reinvested at 3%. The ladder smoothed their reinvestment rate across multiple years, rather than concentrating it in a single, unfavorable year.

How a ladder reduces reinvestment risk

A bond ladder is simple: hold individual bonds with staggered maturity dates. For a $100,000 allocation with 10-year average duration:

• $10,000 bond maturing in 1 year (yield 3.5%)
• $10,000 bond maturing in 2 years (yield 3.7%)
• $10,000 bond maturing in 3 years (yield 3.9%)
• ... and so on to 10 years (yield 4.0%)

In year one, the 1-year bond matures. You receive $10,000 principal and reinvest it into a new 10-year bond (now yielding whatever the market offers). The ladder rolls up: what was a 2-year bond is now a 1-year bond. What was an 11-year bond is now a 10-year bond (if you reinvested into a 10-year). Over time, you are always reinvesting one rung at a time, across all possible interest-rate environments.

This smooths the reinvestment timing and reduces the chance that all your reinvestment happens at a terrible rate. It also preserves the ladder structure: you always have a bond maturing in 1 year, 2 years, 3 years, ..., 10 years.

The Treasury bond ladder advantage

Treasury bonds are ideal for laddering because they have no default risk, deep liquidity, and simple tax treatment (federal tax on interest, exempt from state tax). An investor can build a $100,000 ladder with ten $10,000 individual Treasury bonds, each with a different maturity, and know they are safe. They receive principal back on schedule with no credit risk, and reinvestment timing is spread.

Corporate bonds are less ideal for laddering. First, they carry credit risk. If you own ten different corporate bonds and one issuer defaults, you lose 50–60% of that position. A corporate ladder is not a simple, reliable vehicle. Second, corporate bonds are less liquid for retail. A retail investor might struggle to sell a corporate bond before maturity if circumstances change.

Why most retail investors should use bond funds instead

Building a ladder requires $10,000 per rung (or $5,000 if you are disciplined), and you need at least 10 rungs for a true ladder. That is $100,000 minimum. Furthermore, you must monitor each bond annually, reinvest each maturity, and understand the tax implications of bond sales or defaults.

For most retail investors with under $500,000 in bonds, the effort is not worth the benefit. A low-cost bond index fund (VBTLX, BND, VWRL for international) with an already-optimal maturity structure (weighted toward intermediate duration) does the laddering for you. The fund reinvests coupons automatically, rebalances as bonds mature, and incurs minimal trading costs. You pay a 0.03–0.05% annual fee instead of doing unpaid work.

The only reason to build a ladder is if (1) you have significant capital ($500,000+), (2) you enjoy managing bonds, or (3) you have strong convictions about interest rates and want the optionality a ladder provides.

Concentration mistakes within ladders

Even if you build a ladder, common mistakes remain:

1. Buying speculative-grade corporates in a ladder: A junk-rated bond that defaults impairs the entire rung. A Treasury ladder is safe. A corporate ladder of Ba-rated bonds is a bet on the economy.
2. Building a ladder of callable bonds: Callable bonds can be called early by the issuer, breaking the ladder before you planned. If interest rates fall and a callable bond is called at par, you are forced to reinvest at lower rates.
3. Concentrating in one issuer across rungs: Ten bonds from the same company across ten maturities is not diversification.
4. Using a ladder for speculation: Some investors try to exploit the "steep yield curve" by laddering when short rates are low and long rates are high, expecting to profit when the curve flattens. This is market-timing, not prudent laddering.

How it flows

Example: Treasury ladder in action

An investor with $100,000 built a Treasury ladder in January 2022:

• $10,000 1-year Treasury at 0.8% (matures Jan 2023)
• $10,000 2-year Treasury at 1.4% (matures Jan 2024)
• ... continuing to ...
• $10,000 10-year Treasury at 2.0% (matures Jan 2032)

Blended yield: ~1.2% (a disappointment compared to stock returns, but not bad for safe income).

In January 2023, the 1-year matured. Rates had risen to 4.5% for 10-year Treasuries (the Fed had hiked throughout 2022). The investor reinvested the $10,000 into a 10-year Treasury at 4.5%. The new ladder now had:

• $10,000 1-year Treasury at 4.5% (new)
• $10,000 2-year Treasury at 1.4% (now 1-year remaining)
• ... continuing to ...
• $10,000 9-year Treasury at 2.0% (now 8-year remaining)

The investor benefited from the rate increase by reinvesting at 4.5% instead of being locked into 2.0%. The ladder provided optionality.

Related concepts

• Ignoring Duration Risk
• Buying Bonds Without Tax Context

Next

The next article examines a related but distinct mistake: treating bond funds as a "stable value" vehicle analogous to savings accounts, without accounting for NAV risk.