Bonds & Fixed Income Investments
Ladders, Savings, and Reserves

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By imdajunkman
January 5, 2006

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Fixed-income ladders can be talked about as having "Length" and "Depth". E.g., if you're buying 13-week T-Bills and always rolling the bill that falls off the back end of the ladder (for having matured) forward to the front end again (by reinvesting your principal), your ladder is 13-rungs long and one rung deep (or "wide", or whatever descriptive phrase you want to use).

To put a 13-week ladder in place requires $13,000, obviously. (Actually, a bit less, because you're buying at discount and receiving par at maturity.) The second time you've built a 13-week ladder, you ought to realize that you could have built a 26-week one instead. But that would take $26,000. Let assume you do have the $26k. Is it better to build one 26-week ladder, or two 13-week ladders?

From the viewpoint of obtaining yield, the 26-week ladder is superior (across a wide variety of yield curves, and maybe all historically witnessed ones). However, from the viewpoint of unwinding the ladder to provide nearly immediate cash, a deeper ladder (constructed by buying two bills per week, not one) is the superior choice. In 4 weeks you can get your hands on $8,000, which might be enough to solve whatever cash-flow crisis you are facing (the need to replace a roof, a car, or whatever.) This is the classic choice: less money now versus more money latter.

An aside: Yes, a portion of the ladder, or all of it, could be immediately liquidated, but that is an expensive way to access cash that you own but have invested in short-term debt instruments. The better solution would be to draw upon other credit facilities and then use the maturing bills, as they mature, to pay off the credit facilities, especially if that credit facility is a no-annual-fee HELOC at an advantaged rate like Prime Minus One, as opposed to most people's typical credit facility, an 10-18% credit card.

I can foresee several reason why a person would want to build short-term, fixed-income ladders:

(1) A parking spot for money needed shortly (a targeted objective) that you don't want to expose to investment risk.
(2) A parking spot for money for "rainy days" (a generic and prudent reserve).
(3) A benchmark or touchstone against which the risk/reward ratios of your other financial activities can be measured.

Reason (1) is going to vary according to each individual, as will the allocations to Reason (2). So, let's consider Reason (3), which is often considered the "Cash" component of one's portfolio.

How much cash should a fixed-income portfolio have in order to be optimally efficient? That, again, will [depend on] an individual determination (and I don't want to go into an explanation of Modern Portfolio theory (MPT) since plenty already exist). What I do want to suggest, however, is this idea: "Efficiency be damned!" (at least for a portion of one's money.)

A Treasury ladder (or its equivalent) is a psychological "safe harbor" in the midst of a very unfriendly, very hostile financial world. It might not be the most profitable thing I could be doing with a portion of my money, but it is certainly the most peaceful thing I could be doing. Every week I buy a T-Bill, and every week one comes due. My money has grown a bit, and I have had one less thing to worry about.

Do you remember your first passbook savings account, most likely set up for you by your parents? Banks were very august institutions in those days, no drive-up windows, no decorator interiors to make them seem informal, friendly places to do business. The floors were cold-and-hard, the counters marble-and-brass, as were the tellers. They were institutions not much changed from Charles Dickens' time, and I'm sure if I scoured his pages, I'd find descriptions that would evoke your wry memories.

At heart, I'm still that little guy with his handful of pennies, nickels, and dimes, maybe all of $1.37 worth, who would deposited them in his savings account with the assurance that his money would be safe, and that it would grow. Not quickly, because I didn't know about fast money then, but assuredly.

Nowadays, there's scarcely a risk I won't look straight in the eye to see if I can price it and make a profit. But I'm also up to my ears in risk (as one has to be in order to replace the purchasing power that Central Bankers steal by way of inflation). So it is a huge source of comfort and stability that a portion of my money is Savings and Reserves. The process of constantly building Treasury ladders keeps me in touch with the cycle of interest rates the way that planting a vegetable garden might keep a person in touch with the cycles of the days and seasons. Both are husbandry, one financial, the other horticultural, and both share similarities of patience and growth.


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