I was asked about a reader about whether a gradual and persistent rise in the federal funds rate would deter me from adding to my short term bond ladder.
I am hopefully near or at a completion point. I started building the ladder about thirty days ago in anticipation that the FED will hike the FF rate on or before the July 2017 meeting and again in December 2017. I have now allocated slightly more than $200K to the short term bond/CD ladder.
I have clustered maturities in December 2017 and January 2018 that can be reinvested into higher yielding short term bonds and CDs assuming my future predictions prove prescient including the prediction that there will be a .25% FF increase in December 2017. Another cluster is in the June 2017 through August 2017 period when the FED may increase by .25%.
This clustering approach is one way to address interest rate risk issues related to a rising rate environment.
The FED is scheduled to meet on December 12-13, 2017:
This is a list of maturities in December through January 2018: FRB: Meeting calendars, statements, and minutes (2012-2017)
Principal Value $1K per Bond or CD
4 4 Week Treasury Bills Maturing Per Month
2 AT & T 1.4% (YTM at 1.491%) Senior Unsecured Maturing Due 12/1/17
2 Disney 1.1% (1.043% YTM) Senior Unsecured Maturing 12/1/17
2 Ecolab 1.45% (1.389% YTM) Senior Unsecured Maturing 12/8/17
2 Chevron 1.104% (YTM 1.224%) Senior Unsecured Maturing 12/8/17
2 ConocoPhillips 1.05% (1.203% YTM) Senior Unsecured Maturing 12/15/17
2 Sherwin Williams 1.35% (YTM 1.294%) Senior Unsecured Maturing 12/15/17
1 U.S. Treasury .75% (YTM .95%) Maturing 12/31/17
1 U.S. Treasury Bill .888% (1 YR. Bought at Auction) Due 1/4/18 (scheduled 1 Yr reinvestment)
2 Everbank CDs 1.05% Due 1/11/18
2 BBT 1.45% (YTM at 1.394%) Senior Unsecured Bonds Due 1/12/18
2 C.R. Bard 1.375% (YTM at 1.363%) Senior Unsecured Bonds Due 1/15/18
2 Dominion Resources 1.2% (YTM at 1.507%) Senior Unsecured Due 1/15/2018
2 Brown Forman 1% (YTM at 1.303%) Senior Unsecured Due 1/15/18
1 Deere 1.35% (YTM at 1.35%) Senior Unsecured Due 1/16/18
1 WFC 1.5% (YTM at 1.499%) Senior Unsecured Due 1/16/18
2 Royal Bank of Canada 1.5% (YTM at 1.457%) Senior Unsecured Due 1/16/18
3 Anheuser Busch 1.25% (YTM at 1.342%) Senior Unsecured Due 1/17/18
1 Statoil 1.2% (YTM at 1.325%) Senior Unsecured Due 1/17/18
2 Merck 1.1% (YTM 1.192%) Senior Unsecured Due 1/31/18
1 U.S. Treasury .75% (YTM .946%) Maturing on 1/31/18
1 6 Month Treasury Bill Scheduled for Reinvestment at Auction January 2018
Total Principal Amounts Maturing 12/1/17 through 1/31/18 = $40,000 (about 1/5th of the total allocation).
A significant number of securities will mature prior to 12/1/17 and in February and March 2018.
If short term rates rise over the next several months, and bonds maturing in this time frame decline some, I may buy more.
When the YTM is above the coupon rate, I was able to buy the bond at below par value with the commission. Sometimes, the purchase was made below par but the $1 per bond commission reduced the YTM a slither below the coupon rate.
Generally, several senior unsecured bonds that I now own may be called at par value within one month prior to maturity. An optional redemption prior to then would trigger the make whole provision that would penalize the issuer for exercising its optional redemption right.
In the event an issuer sees rates going up higher, there is a possibility that it will elect to call a bond maturing on 12/15/17 on 11/15/17 for example.
An optional redemption is fine with me when interest rates are rising and I will be able to invest the proceeds in a higher yielding security a month early.
Since I expect short term rates to rise, a short term bond ladder that extends out three years will lose some income simply by having the longer dated maturities. I am dealing with this form of interest rate risk, which I label the risk of lost opportunity, by weighting maturities within the first 18 months compared to the last 18 months.
The risk of lost opportunity can also arise in that weighting when short term interest rates remain stable or decline. In those scenarios, I would have been better off weighting the 18 to 36 month time period since I would receive more income for longer.
The ladder approach is basically designed to mitigate interest rate risk and is based on a recognition that the future is ultimately unpredictable. Something may happen within the next 12 months that will cause rates to plummet or to rise higher than I currently expect.
The short term bond ladder is also a response to four co-existing events: (1) totally inadequate MM fund yields, (2) an abundance of cash in those MM funds; (3) a strong emphasis on capital preservation with no financial need to take risks; and (4) an unwillingness to commit idle cash to stock purchases given the current high valuations. Conditions (2) and (3) are relevant to me and may not be applicable to others. Some investors may believe that stocks are not overvalued. I view the U.S. stock market as clearly overvalued based on any rational short to intermediate term forecast for real earnings growth.
I am also dealing with interest rate risk issues in a variety of ways. I have been selling several exchange traded bonds that were recently bought during the last price correction that have rallied in price. I would then look for opportunities to buy buy at lower prices.
I have a number of bonds and preferred stocks that are floaters and could benefit from rising interest rates when that scenario results in coupon increases.
And, I still have a substantial cash reserve that can be drained without selling something in the event that particular stocks provide a more attractive entry point than now.