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How can I invest in bonds without having to guess where interest rates are going?

For many investors, investing in stock and bond markets can be confusing. In the case of fixed-income investing -- bonds being a typical example -- part of the uncertainty comes from trying to decide whether you should lock in for a long or short period.

If you think interest rates are set to fall, you might figure it's best to put your money in bonds that don't mature for several years. This would let you benefit from what would be relatively high interest earnings.

Or if you believe interest rates are set to rise, you might decide to lock in for a very short period of time so you can turn around and reinvest at those higher rates you think are around the corner. Predicting the direction of interest rates isn't easy. Fortunately, there is a simple way to invest in bonds without having to worry about what way interest rates are going.

Building a bond ladder

Instead of having all your bonds come due at the same time, you could spread out the maturity dates by building a bond ladder. This avoids the risk of having all your bond money up for renewal at the same time when rates might be low. If rates have gone up when you renew, some of your bonds would catch the higher rate.

With your maturity dates staggered, you have income stability. By building a ladder, you have a simple way to manage your bond portfolio yourself and you can avoid paying management fees, which would be the case, if you held your bonds in a mutual fund.

As each bond comes due, it's renewed at the same rate as the longest term bonds in your ladder. By using this conservative approach, you don't have to try to guess where interest rates are headed. Let's say you want a five-year bond ladder. You could buy a Government of Canada one-year bond, a two-year bond, a three-year, a four-year and a five-year. As each bond comes due, just remember to renew it for five years. A year from now, your one-year bond would come due. You would renew it for five years. When the two-year bond comes due in two years, it would be renewed for five years, and so on. This strategy minimizes the risk of having to renew in a falling interest rate environment.

A bond ladder is a way of maintaining liquidity in your bond portfolio since part of the money is coming up for renewal each year.

You could, of course, modify the standard bond ladder approach by adding some flexibility. For example, you might deliberately lock in some of your money for longer than the usual five-year term as it matures. This would be an option to consider during periods of high interest rates, if you want to lock in those higher rates for longer than your usual five years.

Investments suitable for one investor might not match your needs. Consider seeking professional investment advice.