Latest / Inflation and Your Money with Fexingo: Protecting Purchasing Power and Beating Inflation / How Inflation Is Hurting Bond Ladder Strategies Right Now
Transcript
- Lucas: So the bond ladder — that classic strategy where you buy bonds with staggered maturities to get both income and flexibility — is quietly losing its inflation fight right now. Luna: And this isn't about default risk or interest rate spikes. It's simpler than that. The math just doesn't add up anymore. Lucas: Exactly. Let's use concrete numbers. As of this week, a typical 1-year Treasury is yielding around 4.2 percent. Meanwhile, the May CPI reading came in at 334.0 — that's about 5.1 percent annualized inflation over the last three months. Luna: So you're earning 4.2 percent nominally, but losing roughly 0.9 percent in real terms every year. That's the inflation tax on a bond ladder. Lucas: And it gets worse if you're laddering across 2-year and 3-year maturities. The 2-year Treasury is closer to 3.9 percent. The 3-year around 3.8 percent. So the longer your ladder's average duration, the more negative your real yield becomes. Luna: Right, because the yield curve is still inverted — shorter maturities pay more than longer ones. So a traditional ladder that used to smooth out your income is now actually dragging down your real return. Lucas: Exactly. And this isn't a temporary blip. The 10-year breakeven inflation rate — that's the market's expectation for average inflation over the next decade — hit 2.31 percent this week, up from 2.29 percent last month. Luna: So the market itself is pricing in higher inflation ahead, which means bond investors are getting compensated even less in real terms going forward. Lucas: Right. So what do you do if you're relying on a bond ladder for retirement income or a fixed-income allocation? One option is to shift to a TIPS ladder — Treasury Inflation-Protected Securities. Luna: TIPS adjust principal for inflation, so the real return is guaranteed. But right now, TIPS yields are also negative — the 5-year TIPS is yielding about negative 0.6 percent real. Lucas: That's still better than losing 0.9 percent real on a nominal Treasury. But it's not great. Another option is I Bonds — Series I savings bonds — which currently have a composite rate of about 4.3 percent, based on the May CPI. Luna: I Bonds have that purchase limit — ten thousand dollars per person per year — so they're not a full solution for a large portfolio. But they can anchor the short end of a ladder. Lucas: Exactly. A barbell approach might make sense: use I Bonds for the first year or two of expenses, then build a TIPS ladder for years three through seven. You'd give up some liquidity, but you preserve purchasing power. Luna: And what about just shortening the ladder even further? Like using a 3-month Treasury bill ladder instead of 1-year or 2-year? Lucas: That helps on the liquidity front, and 3-month bills are yielding close to 4.3 percent right now. But you're still earning a negative real return. The only way to get a positive real yield in Treasuries today is to go out to 10 years or longer — and then you take on significant duration risk. Luna: So the classic 'ladder and forget it' strategy is broken for now. You have to actively manage the inflation component. Lucas: And that's the real takeaway. If you set up a ladder two years ago when inflation was lower, you might be rolling over maturing bonds into much lower real yields today. That's a silent portfolio drag. Luna: Real quick — and this is a bit of a personal note — our ability to keep having these detailed money conversations without ads or sponsors is genuinely thanks to listeners who chip in a couple of dollars a month. If our inflation coverage has helped you rethink a strategy like this, buy me a coffee dot com slash fexingo makes a real difference. It's what keeps the show independent. Lucas: Yeah, and we mean that. Small contributions add up. So if you've gotten value, that's the place. Now back to bond ladders — there is actually one corner of the market where real yields are positive right now. Luna: Municipal bonds? Lucas: Specifically, high-quality munis with 5 to 7 year maturities. They're yielding around 3.5 percent tax-free, which for someone in a 32 percent federal bracket is equivalent to about 5.1 percent taxable. That beats inflation. Luna: But that adds credit risk and state-specific risk. It's not a pure inflation hedge — it's a tax arbitrage play. Lucas: Absolutely. It's not for everyone. But if you're in a high tax bracket and you itemize, it's worth running the numbers. The point is, the old bond ladder playbook needs updating for this inflation regime. Luna: Let's talk about how to actually implement that. If someone has a $50,000 ladder maturing this month, what's the smartest move? Lucas: I'd split it three ways. Put ten thousand into I Bonds for the first rung. Take twenty thousand and build a 5-year TIPS ladder — buy individual TIPS at auction, not the ETF, so you control the maturity dates. And the remaining twenty thousand, use for a short-term muni bond ETF if you're in a high bracket, or a Treasury money market fund if you're not. Luna: That gives you inflation protection, some tax efficiency, and liquidity. Not bad for a hybrid approach. Lucas: And the key is to revisit it every six months. Inflation expectations change, the yield curve shifts. A set-it-and-forget-it ladder is a recipe for negative real returns right now. Luna: So the takeaway: bond ladders still work for cash flow planning, but you need to layer in inflation protection or you're slowly losing ground. Lucas: Exactly. And that's the kind of adjustment that keeps your portfolio honest in a world where the Fed is pausing at 3.63 percent and inflation is still running above 5 percent. Luna: Alright, next episode we'll look at whether floating-rate notes are a better alternative for the short end of a ladder. Lucas: Good call. See you then.