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When you’re on a ladder, you forego interest

Q

If dollars from the sale of bonds with looming call dates are used to purchase cheaper, longer- term bonds, would this lengthen the average maturity or call dates in my portfolio? If so, would this cause an increase in risk due to rising interest rates that seem predictable over the next few years? For example, if I replace many of my shorter-term bonds with longer-term ones and interest rates rise, I might be sacrificing the opportunity to buy bonds later at higher rates. As you can probably tell, my muni bonds are currently arrayed in a “ladder.”

D.T.

A

James A. Klotz responds:

It is difficult to give you a definitive answer to the first part of your question without knowing the maturity dates of the bonds to which you refer, which have “looming calls,” since not all callable bonds are actually called.

If these bonds are short term in nature, you will certainly be lengthening your average maturity, but you would also increase your tax-free income significantly.

The market value of longer-term bonds will fluctuate more than shorter bonds, but you sound like a buy-and-hold investor, rather than a trader, and you probably never sell your bonds.

While being overly concerned about the opportunity you may miss down the road if interest rates rise, you might want to give some thought to what you are currently sacrificing, on an annual basis, in re-investable income and what you have already lost by having to continually reinvest your laddered portfolio at lower rates over the last 10 years.

If you are employing a 10-year ladder, you could be foregoing 40% to 60% of the tax-free income available on quality bonds. Increasing your income to this extent would provide a cushion of investable dollars, above what you are currently earning, for reinvestment at higher rates if the opportunity does arise. Keep in mind, the cost of waiting for higher rates is unrecoverable.

Apr 23, 2012

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