Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / How Early Retirees Handle Sequence Risk with Bond Ladders
Transcript
- Lucas: So, we've talked a lot about withdrawal strategies on this show — buckets, guardrails, the 4 percent rule. But today I want to get into something that's a bit more mechanical, and honestly, a bit more comforting: the bond ladder. Luna: Comforting? That's a strong word for fixed income. Lucas: It is, but think about it. When you're living off your investments, the biggest fear is that the market drops right when you start withdrawing. That's sequence risk. And a bond ladder directly addresses that by giving you a stream of income that doesn't depend on what the stock market does on any given day. Luna: Right, we touched on that in the bucket strategy episode. But how is a bond ladder different? Lucas: It's simpler in some ways. You buy individual bonds with staggered maturity dates. Say you need $50,000 a year from your portfolio. You might build a ladder with ten rungs, each one a bond that matures in a different year — one, two, three, all the way out to ten years. As each bond matures, you get your principal back, and you use that to cover your living expenses for that year. Luna: So you're not selling anything at a loss if the market is down, because the bond matures at par. Lucas: Exactly. The bond pays you its face value at maturity, no matter what the price did in between. So as long as the issuer doesn't default, you know exactly how much cash you're getting and when. That's the comfort. Luna: But what about the opportunity cost? If stocks are ripping, you're locked into those lower-yielding bonds. Lucas: You're right, and that's the trade-off. You're giving up potential upside for certainty. But for the money you need in the next five to ten years, certainty is often more valuable than upside. You sleep better knowing your next few years of expenses are covered. Luna: So how do you actually build one? Do you just go to your brokerage and buy ten different bonds? Lucas: Pretty much. You can build a ladder with Treasury bonds, which are as risk-free as it gets. Or you can use municipal bonds if you want tax-free income, especially if you're in a high tax state. You just buy bonds with different maturity dates, and you can set up an auto-reinvest or just let them mature and spend the cash. Luna: But aren't individual bonds a pain to manage? You have to research credit quality, call features, stuff like that. Lucas: That's where I'd push back a little. If you stick to Treasuries or high-quality munis, credit risk is minimal. You don't need to research much. The main thing is to avoid callable bonds, because the issuer could redeem them early, which disrupts your ladder. And you want to keep maturities in the one to ten year range, because that's your spending horizon. Luna: So what's the alternative? Just a bond fund? Lucas: Right, a bond fund like a total bond market ETF. But the problem is that a fund doesn't have a maturity date. It's a perpetual pool of bonds, so the price fluctuates with interest rates. If rates go up, the fund's net asset value drops. You could be forced to sell at a loss if you need to withdraw. With a ladder, you hold to maturity, so you avoid that price risk on the rungs you actually spend. Luna: But you're still reinvesting the income from the ladder at whatever rates are available when the bonds mature. Isn't that reinvestment risk? Lucas: Yes, but it's a different flavor. With a ladder, you know the exact amount you'll get at each maturity. If rates have fallen, you might get less on the next rung when you reinvest, but you've already locked in the returns for the next ten years roughly. And you can mitigate that by building the ladder with a barbell strategy or using a mix of maturities. Luna: Let's talk about costs. What do you actually pay to buy individual bonds? Lucas: That's a good question. Brokers often add a markup on bond trades, which isn't transparent like a stock commission. But you can check the yield against a benchmark to see if you're getting a fair price. For Treasuries, you can buy them directly from the government at auction, so the cost is zero. That's the purest way to build a ladder. Luna: So you're saying you could build a whole ladder of Treasury bonds with no fees at all? Lucas: Yeah, if you buy at auction. You set up a TreasuryDirect account, and you can buy bills, notes, and bonds with the maturity you want. The Treasury holds regular auctions for each term, so you can build your ladder one rung at a time. It's a bit clunky, but it's free. Luna: But what about the current yield environment? We're in August 2026, and rates have been all over the place. Are bond ladders still attractive? Lucas: That's the thing — bond ladders are attractive in any environment, because the purpose isn't to maximize returns. It's to match your income to your expenses. Right now, you can get decent yields on short and intermediate Treasuries, actually. The yield curve is not as inverted as it was a couple years ago, so a ten-year ladder might give you an average yield of around 4 percent. That's not nothing. Luna: But what about inflation? If inflation runs hot, a 4 percent yield might not keep up. Lucas: You're right, and that's why many early retirees pair a bond ladder with a TIPS ladder — Treasury Inflation-Protected Securities. We covered that in Episode 128. The idea is that you might have a TIPS ladder for the first few years of retirement to cover essential expenses, and then a nominal bond ladder for the rest. That way, you have inflation protection on the near-term rungs. Luna: So you're building two ladders? That sounds like a lot of moving parts. Lucas: It can be, but you don't have to overcomplicate it. A simple approach is to just use a Treasury ladder for all your fixed income. The Social Security cost of living adjustment and your stock portfolio will provide some inflation protection over the long run. The ladder is mostly there to cover the gap until those other sources kick in. Luna: That makes sense. So the ladder is like your base income, and the stocks are for growth and inflation fighting. Lucas: Exactly. And that's why the ladder is so comforting. It's the floor. You know that for the next five or ten years, your essentials are covered, no matter what the market does. That gives you the psychological freedom to ride out a downturn without panic-selling. Luna: I've heard some people say they like to have a 'cash bucket' instead of a bond ladder. Is that just a different name for the same thing? Lucas: Sort of, but cash doesn't earn much. These days you can get five percent in a money market fund, so that's been a fine substitute. But the issue is that cash yields are variable and can drop quickly if the Fed cuts rates. A bond ladder locks in rates for the duration, so you have more certainty. Luna: Good point. So what about taxes? If you use a bond ladder in a taxable account, you're paying taxes on the interest each year. Lucas: Right. That's why it's usually better to hold bonds in tax-deferred accounts like a traditional IRA or 401. But if you're in early retirement, you might be doing a Roth conversion ladder, and that complicates things. Many early retirees end up with a blended approach — some bonds in taxable, some in tax-deferred — and they manage the mix for tax efficiency. Luna: So what's a simple way to implement a bond ladder for someone who doesn't want to buy individual bonds? Lucas: You can use an ETF that holds a defined portfolio of bonds with staggered maturities. For example, there are target-maturity bond ETFs that mature in a specific year, kind of like a bond ladder in a wrapper. You can buy a few of those to create your own ladder. It's easier than picking individual bonds, but you do pay an expense ratio. Luna: And you still get the benefit of holding to maturity? Lucas: Yes, if you hold the ETF to its maturity date, you get the principal back, minus the expense ratio. So it's a pretty clean way to build a ladder without the hassle of managing individual bonds. Luna: Speaking of hassle, what are some common mistakes people make when building a bond ladder? Lucas: The biggest one is not matching the rungs to your actual spending needs. If your expenses are lumpy — say you need a new car in three years — you might want a larger rung then. But if you just build ten equal rungs, you might come up short. So you want to tailor the ladder to your cash flow. Luna: Right, that makes sense. Another mistake might be ignoring the call features, like you mentioned earlier. Lucas: Yeah, if you buy a callable bond and rates drop, the issuer might call it away, and you're stuck reinvesting at lower rates. Stick to non-callable bonds, especially Treasury and most munis, to avoid that risk. Luna: And what about the duration? If you build a ten-year ladder, your average duration is about five years, so your portfolio value will still fluctuate with rates. But you don't care because you're holding to maturity, right? Lucas: Exactly. You need to have the discipline to not look at the market value. The only number that matters is the cash flow you've locked in. That's the whole point. Luna: Okay, so we've been talking about bond ladders as a way to manage sequence risk. But I'm wondering, is this something that's more relevant for a certain type of early retiree? Lucas: I think it's especially useful if you have a moderate portfolio, say twenty-five to fifty times your annual expenses. If you're on the leaner side, you might need more growth and rely on stocks more. If you're very wealthy, the sequence risk is less of a concern. But for the typical early retiree, a bond ladder can be the backbone of your income plan. Luna: So let's say someone is listening and they want to build a bond ladder. What's the first step? Lucas: First, figure out your annual expenses and how much of that you want to cover with the ladder. Let's say you decide to cover three years of expenses, so $150,000. Then you decide on the maximum maturity, maybe seven years, and you buy bonds that mature in one, two, three, four, five, six, and seven years. Each rung is about $21,000. That's a simple ladder. Luna: And you'd do that in a tax-advantaged account if possible. Lucas: Right. And if you're building it in a taxable account, use municipal bonds if you're in a high tax bracket. Otherwise, Treasuries are fine. You can even mix in some corporate bonds for a bit more yield, but keep the credit quality high. Luna: So, what about the current market? Are there any special considerations given where rates are now? Lucas: Given that we're in August 2026, and the Fed has been navigating a tricky path with inflation, I'd say the key is to not try to time the market. Build your ladder based on your spending needs, not on a rate forecast. If rates are higher than you'd like, you can start with shorter rungs and extend over time as bonds mature. Luna: That seems like a prudent approach. I think we've covered a lot of ground here. But I'm curious, do you think bond ladders are for everyone? Lucas: No, they're not for everyone. If you have a very short time horizon, cash might be better. If you have a very long time horizon, stocks might be better. But for that sweet spot of early retirement, they're a powerful tool. And you know what, this kind of conversation is exactly why we do this show. Luna: What do you mean? Lucas: Well, we talk about these strategies because we want to help people make informed decisions about their money. And we deliberately don't run ads because we want the content to be pure, no noise. So if you've been getting value from these episodes, and you want to support that mission, you can do that by buying us a coffee at buy me a coffee dot com slash fexingo. It's just a nice way to say thanks, and it keeps the show ad-free. Luna: Yeah, I think that's a good point. And honestly, it's like a small gesture that goes a long way in helping us keep doing this. Lucas: No pressure, though. We're just grateful you listen. Anyway, back to bond ladders. One more thing I want to mention is that you should review your ladder annually and adjust for any changes in your expenses or tax situation. It's not a set-and-forget thing. Luna: That's a good reminder. So, to wrap up, what's the key takeaway for today? Lucas: I'd say that a bond ladder is a practical way to reduce sequence risk by creating a predictable income stream for your early retirement years. It's not about maximizing returns; it's about buying certainty. If you pair it with a well-diversified stock portfolio, you can sleep well at night knowing your next few years are covered. Luna: And that's the financial freedom we're all after. Thanks for joining us today, and we'll see you next time.