You will be able to explain how a ladder spreads maturities to manage interest rate and timing risk.
Wei Ling and Jun Hao have S$45,000 saved and three big bills ahead: their wedding in about a year, the payment when they collect the keys to their flat in about two years, and the renovation soon after, about three years out. Jun Hao wants to put the whole sum into one product at the best rate they can find. Wei Ling worries about what happens if rates move, or if they need part of it early. Both concerns are fair, and a ladder answers both of them.
A ladder splits one sum across several instruments that mature on different dates. Each one is a rung. Instead of one deposit or bond with one maturity, you hold a sequence: some money coming due soon, some a bit later, some later still.
For Wei Ling and Jun Hao, a simple version has three rungs of S$15,000 each. The first matures in about 12 months, just before the wedding; the second in about 24, ahead of key collection; and the third in about 36, before the renovation starts. Every rung has its own bill, its own amount and its own date.
The instruments for each rung come from this course. Short rungs can use T-bills or fixed deposits. Longer rungs can use fixed deposits with longer terms, SSBs, which you can redeem at face value in any month, or SGS bonds that mature on or before the date. Lesson 8.2, Match rungs to the dates you need money, shows how to choose for each one.
In module 2 you saw that bond prices fall when yields rise, and in lesson 2.3, Duration: how far a price moves when rates move, that longer bonds fall more. That risk is real if you might sell before maturity.
A ladder sidesteps it. Each rung is held until it matures, and at maturity a bond, bill or deposit pays its full face value. Whatever happens to prices in between, the third rung pays S$15,000 on its date. If rates jump in year two, the price of the third rung might dip on paper, but Wei Ling and Jun Hao never sell it, so the dip never becomes a loss.
That is the main thing a ladder buys you. It turns timing risk, the danger of needing money just when prices are down, into something you have planned around. The money for each bill is in an instrument that ends before the bill arrives.
Compare that with keeping all S$45,000 in a bond fund with a duration of 6. A one point rise in yields a few months before the wedding could cut it by about S$2,700, with no date on which the fund has to recover, and that is precisely the gap a ladder closes.
Jun Hao's plan to lock everything at one rate is a bet on timing. Should rates rise after they lock in, the whole sum is stuck at the lower rate, and should rates fall, they come out ahead. Nobody knows which in advance, as you saw in lesson 4.5, SGS bonds for money with a longer horizon.
A ladder spreads that bet. Each rung locks in the rate for its own term at the time it is placed, and the rungs have different terms. When a ladder is kept going for longer, each maturing rung that is not needed yet is reinvested at whatever rates are on offer then, at the far end. Over time the ladder holds a mix of rates set at different times, so you never commit everything at one moment's rate. You give up the chance of having timed it perfectly, and in return you avoid having timed it badly.
In a goal ladder like Wei Ling and Jun Hao's, most rungs get spent rather than reinvested, so there is less averaging, though the dates still line up with the bills.
A ladder is a tool for money with a known date. It works because each rung has a job and a deadline.
Long-term money with no date, such as retirement savings decades away, does not need a ladder. It needs a portfolio that can grow over time, which usually includes shares and may include a bond fund, as lesson 7.3, When owning the bond beats owning the fund, described. Putting long-term money into a ladder of deposits and bills keeps it safe from price falls, but it also keeps it growing slowly for decades when it did not need that protection. How money works, lesson 2.3, Estimate doubling time in your head with the rule of 72, shows how large that difference becomes over long periods.
Wei Ling and Jun Hao agreed to try the three-rung version. Before choosing a single instrument, write down how a three-rung ladder would work for a sum you need in parts over the next three years.
Describe in three sentences how a three-rung ladder would work for a sum you need in parts over the next three years.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).