Latest / Inflation and Your Money with Fexingo: Protecting Purchasing Power and Beating Inflation / How Inflation Is Quietly Eating Your Bond Ladder
Transcript
- Lucas: So Luna, we have talked a lot on this show about how inflation quietly chips away at different parts of our financial lives—whether it's your emergency fund or your dividend stocks—but we haven't yet looked at one of the most classic retirement tools: the bond ladder. And honestly, right now, with the federal funds rate sitting at 3.63 percent and the ten-year breakeven inflation rate just falling to 2.27 percent, it's a perfect moment to drill into it. Luna: The bond ladder—that's where you stagger bond maturities so you have cash coming due at regular intervals, right? Lucas: Exactly. You buy bonds that mature in one, two, three, four, five years—or longer—and as each rung matures, you reinvest the principal into a new bond at the other end. The idea is that you smooth out interest rate risk and always have money available without ever having to sell at a bad time. It's considered one of the safest ways to generate retirement income. Luna: Safe from an interest rate perspective, sure. But what about inflation? That's the silent killer we keep coming back to. Lucas: Right. And that's the angle I want to dig into today. Because a bond ladder can still lose purchasing power even if you never miss a single interest payment. Let me give you a concrete example. Say a retiree has five hundred thousand dollars in a five-year ladder built back when yields were much higher—maybe around five percent, which was possible a couple of years ago. That ladder is now throwing off about twenty-five thousand dollars a year in interest. But as each rung matures, you're reinvesting into today's yields, which are significantly lower. Luna: So the income stream is shrinking over time, even if the principal stays intact. Lucas: Exactly. And the effect is compounded by inflation. The Consumer Price Index for all urban consumers was at 332.8 in June, up from 332.57 the month before. So prices are still rising, just more slowly. But even at a two-point-three percent inflation rate—which is roughly what the bond market is pricing in for the next ten years—your purchasing power is getting cut every single year. If your bond ladder is yielding, say, three percent on new money, your real return is less than one percent. Luna: That's brutal for a retiree. So what's the typical advice for someone who thought they were playing it safe? Lucas: Well, the standard advice is to keep your maturities short, because short-term bonds are less sensitive to rate changes and you can reinvest sooner. But that also means you're constantly reinvesting at whatever the current rates are—which, right now, are heavily influenced by the Fed holding at 3.63 percent. If the Fed starts cutting rates, your ladder's new rungs will be at even lower yields. Luna: So you're locked into lower rates, and inflation keeps eating away. There's no escape. Lucas: There are options, but they come with trade-offs. One is to add TIPS—Treasury inflation-protected securities—to the ladder. TIPS adjust their principal with inflation, so your real return is protected. But the real yield on TIPS right now is barely positive. I think the ten-year TIPS real yield is around zero point five percent. So you're not getting rich, but you're not losing ground either. Luna: And I-bonds? Those seem like a favorite for inflation protection, but they have those purchase limits. Lucas: Right, I-bonds are great for a portion of your ladder, but you can only buy ten thousand dollars per person per year. So for a five-hundred-thousand-dollar ladder, that's a drop in the bucket. But it's still worth doing for the first rung or two, because the composite rate is tied to inflation and resets every six months. Luna: So you're building a hybrid ladder—some TIPS, some I-bonds, some nominal bonds. That's a lot more complex than the classic advice. Lucas: It is, and that's the reality of today's environment. The days of buying a five-year Treasury at four percent and just forgetting about it are gone. The ten-year Treasury is yielding somewhere around 3.9 percent right now, but with breakeven inflation at 2.27 percent, your real yield is only about 1.6 percent. And that's if you hold to maturity and don't have to sell early. Luna: And if you do have to sell early, you could get hit by price swings. But I guess that's the point of a ladder—you don't have to sell early. Lucas: Right, the ladder reduces that risk. But here's the thing that most people overlook: the reinvestment risk is just as dangerous. When that five-hundred-thousand-dollar bond matures and you reinvest it at three percent instead of five percent, you're permanently locking in a lower income stream. And over a twenty-year retirement, that difference is huge. Luna: So what's the takeaway for someone who's already built a ladder and is nervous about this? Lucas: First, don't panic. Second, consider shortening the duration of your ladder. If you have a ten-year ladder, maybe shorten it to five years. That way, you're reinvesting more often, and you can take advantage of rate changes more quickly. Third, look at adding TIPS to the longer rungs, because those are the ones most exposed to unexpected inflation. Luna: And maybe keep a portion of your cash in a high-yield savings account or a money market fund for the near term, even if it's not part of the ladder. Lucas: Yeah, that's a smart move. Money market funds are yielding around three point five percent right now, which is actually higher than many short-term bonds. So for the first year or two of expenses, you could keep that in cash and not worry about locking in a low rate. Luna: It's like a bond ladder but with more flexibility at the short end. Lucas: Exactly. And you know, one thing we haven't mentioned is the tax angle. If you're in a high tax bracket, municipal bonds might make sense for part of your ladder, but you need to compare after-tax yields. That's another layer of complexity. Luna: Right, because the tax-free yield might be lower, but after taxes it could be better. Lucas: Exactly. So there's no one-size-fits-all answer. But the key is to be intentional about the real return, not just the nominal yield. And that's something I think a lot of people miss. They see a three percent yield and think they're making money, but after inflation and taxes, they might be losing purchasing power. Luna: It's like we keep saying on this show, inflation is the silent tax. Lucas: It really is. And that's why we do this show, honestly. Because the more we talk about these things, the more we hope people make decisions that protect their future. And that's a good moment to mention that if you've found value in these conversations, and if today's episode was worth a coffee to you, you can support us at buy me a coffee dot com slash fexingo. It's a small way to keep this podcast ad-free and independent. Luna: Yeah, every little bit helps us keep the lights on, so to speak. And we appreciate it. Lucas: So back to the bond ladder. One more thing I want to touch on is the current market context. Gold is up over three percent on the week, trading around forty-four seventy-five an ounce. That's a classic inflation hedge, and some people are using that as an alternative in their portfolio. But gold doesn't generate income, so for a retiree who needs cash flow, it's not a replacement for a bond ladder. Luna: Right, you can't sell a gold bar to pay your electricity bill. At least not easily. Lucas: Exactly. So the bond ladder still has a role, but you have to manage it actively. And that's the real message of this episode: a bond ladder is not a set-it-and-forget-it strategy anymore. You need to review it at least once a year, look at the real yields, and adjust for inflation expectations. Luna: And that's something people can do themselves, or with a financial advisor. But they need to ask the right questions. Lucas: Yeah, like 'What's my real return after inflation?' and 'How much of my ladder is protected against unexpected inflation?' If you can answer those two, you're ahead of most investors. Luna: So for our listeners who are retired or nearing retirement, what's one action they can take this week? Lucas: Pull up your ladder and calculate the weighted average yield. Then subtract the current breakeven inflation rate—which is about 2.27 percent for ten years. If your real yield is less than one percent, you need to rethink your strategy. Maybe mix in some TIPS or shorten the duration. And don't forget to consider I-bonds for that first rung. Luna: That's a concrete step. And it's something you can do in an evening. Lucas: Absolutely. And if you do that, you'll have a much clearer picture of whether your bond ladder is truly protecting your purchasing power, or if it's just giving you the illusion of safety. Luna: And that's the real goal, isn't it? Not just to have money, but to have money that can buy what you need. Lucas: Exactly. So take a look at your ladder, do the math, and make sure your retirement income is actually going to be there when you need it. Thanks for joining us on this episode of Inflation and Your Money. We'll see you next time.