Your blog is outstanding! I had a question about bond ladders; some people like Larry Swedroe feel that constructing a ladder of individual bonds may be more advantageous than holding a bond fund. What are your thoughts? Thank you! http://www.cbsnews.com/8301-505123_162-37841787/how-to-build-a-bond-portfolio/?tag=mwuser (Is there any way you can add a search engine for your blog; I couldn't find one to search for "bond ladders")
Glad you are liking my blog! I moved up the "Search" feature on the right-hand side -- it was buried all the way at the bottom before. Thank you for that suggestion.
As far as bond ladders go, I agree with most of what Larry Swedroe says in that article and I agree that a bond ladder can absolutely replace a bond fund but with a condition that, unfortunately, makes bond ladders impractical today.
That condition is that nobody should sacrifice diversification of a bond fund for the few nice, but ultimately minor advantages of a bond ladder. You should not attempt to build a ladder using individual corporate or municipal bonds because you would immediately be exposing yourself to a lot of undiversified risk. I would not do this even with AAA-rated securities. The only kinds of bonds I would feel comfortable laddering are US treasuries and TIPS. Not that US could never possibly default, but if/when it does the whole financial world will more or less go to heck in a handbasket anyway. There will be no fixed income securities that would not tumble along with the US treasuries. It's just not the type of risk that can be diversified away, so you would not be sacrificing any diversification by laddering treasuries or TIPS. There is also a more practical reason to limit bond ladders to treasuries and TIPS -- they are the most liquid of bonds in case you need to liquidate your holdings for whatever reason. But it is the lack of diversification, not lack of liquidity, that is the major reason to not ladder corporates or municipals.
Having established that only treasuries and TIPS are suitable for laddering, we have to ask ourselves whether they are worth holding at all -- in a ladder or otherwise -- at today's valuations. The answer there is a pretty clear no. Their yield is 0.5-1.0% less than what it should be. You can trivially obtain equivalent safety from default, better safety from rising interest rates, and higher yield from FDIC-insured CDs with an option to break early, such as available from PenFed. EE-Bonds are similarly attractive relative to longer treasuries. TIPS are likewise easily trumped by I-Bonds.
So the kinds of ladders I would be looking to build today are using those three types: CDs, I-Bonds, EE-Bonds. In fact, I-Bonds and EE-Bonds naturally become ladders of sort since you can only buy $10,000 of each per year per Social Security number. So you'll have $10,000 in 2012, another $10,000 in 2013, and so on. I-Bonds, of course, can be redeemed at any time with little or no penalty so you can think of them outside of ladder terms. EE-Bonds do have 20-year maturities to capture meaningful return, so they more naturally fit the ladder metaphor.
About the only non-CD/I/EE security I would consider laddering today are 30-year TIPS in a tax-advantaged account (not in taxable). It doesn't feel great to lock into today's 0.4-0.5% real return for 30 years, but that's still better than be guaranteed by alternatives. Not that those alternatives are unlikely to match or exceed it -- just that they can't guarantee it and, historically, there have been times when even such low real returns would have been desirable. So I don't think it's crazy to start or continue building a 30-year TIPS ladder even at today's rates. For just about every other nominal treasury bond or TIPS you can do better by building ladders using CDs, I-Bonds, and EE-Bonds -- not to mention by simply holding diversified corporate and/or muni bond funds.