Smart Bond Investing—Smart Bond Strategies
Just as with other types of investments, there are strategies that can be used when investing in bonds that can help achieve certain goals:
Bond Laddering is a strategy that uses "maturity weighting," which involves dividing your money among several different bonds with increasingly longer maturities, and is frequently recommended for investors interested in using bonds to generate income. Laddering is used to minimize both interest-rate risk and reinvestment risk. If interest rates rise, you reinvest the bonds that are maturing at the bottom of your ladder in higher-yielding bonds. If rates fall, you are protected against reinvestment risk because you have longer-maturity bonds at the top of your ladder that aren't exposed to the drop.
Bond Swapping involves selling one bond and simultaneously purchasing another similar bond with the proceeds from the sale. Why would you engage in this practice? You may wish to take advantage of current market conditions (e.g., a change in interest rates), or perhaps a change in your own personal financial situation has now made a bond with a different tax status appealing. Bond swapping can also cause you to receive certain tax benefits. In fact, tax swapping is the most common of bond swaps.
Reinvestment of Interest Income is a strategy in which you reinvest your bond interest (coupons). If you buy individual bonds, this takes discipline because you need to put each coupon payment you receive to work earning interest rather than spend it. Consider putting them in a brokerage money market account, or even opening a standard savings account just for your coupon payments. At the end of each year, you can put them into the next bond in your laddering strategy.