Build a Bond Ladder

Use these ETFs to navigate a tricky market and manage cash flow.

- NELLIE S. HUANG

THE BOND WORLD CAN SEEM set in its ways, but once in a while an innovative product comes along to upend the notion. In this case, we’re talking about target-maturity bond exchange-traded funds, currently offered by Invesco and iShares. The ETFs invest in bonds in a particular sector—corporate debt or municipals, say—with all of the bonds maturing in a specific year. How the ETFs work takes some explaining, and they’re not right for everyone. But they offer investors some unique benefits.

Though not well known to many investors, these ETFs are not exactly new. The earliest of these types of funds, an iShares series of target-maturity muni bond ETFs, arrived in 2010. But target-date bond ETFs are growing in popularity, especially among investors who are nearing retirement or already retired.

There’s a lot to like, starting with the fact that, like individual bonds that you buy and hold to maturity, these ETFs “mature.” Come December of their target year, the funds close and return all of the capital to shareholders. “It’s like buying and holding to maturity a single bond, except that it’s a fund that holds hundreds of bonds,” says Karen Schenone, head of fixed-income strategy for iShares.

That’s chiefly what makes these funds easy to incorporate into a bond ladder, an old-school technique to boost yields and reduce interest rate risk without locking up all of your money for the long term. You spread your investments across bonds with staggered maturities—the “rungs” of the ladder—and as portions of your portfolio mature at regular intervals, you reinvest the proceeds in another rung further up the maturity line (or spend the cash or invest it elsewhere).