Explain how a ladder spreads maturities across dates to manage interest rate risk and timing risk.
Savings are often meant for bills that fall due at different times over the next few years. If you put all of it in one deposit or bond with one maturity, the money may not come due when each bill does. If you then have to sell early to pay a bill, you may be selling when prices are down.
A ladder splits one sum across several instruments that mature on different dates. Each instrument is a rung. Instead of one deposit or bond with one maturity, you get a sequence: some money comes due soon, some later, some later still. In a goal ladder, each rung is tied to a specific bill, with its own amount and its own date.
Wei Ling and Jun Hao have S$45,000 saved (an invented example) and three big bills ahead. Their wedding is in about a year, the payment when they collect their flat keys is in about two years, and the renovation is in about three years, soon after key collection. 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 the money early. Both concerns are fair, and a ladder answers both.
A simple three-rung ladder for them puts S$15,000 in each rung. Rung 1 matures in about 12 months, just before the wedding. Rung 2 matures in about 24 months, ahead of key collection. Rung 3 matures in about 36 months, before the renovation starts.
To build a goal ladder:
List the bills ahead, each with its amount and approximate date. Split the sum into one rung per bill. Give each rung a maturity that falls just before its bill. Pick an instrument for each rung from this course: T-bills or fixed deposits for short rungs, and longer-term fixed deposits, SSBs or SGS bonds for longer ones. Hold each rung to maturity and do not sell early. In a rolling ladder only, reinvest a maturing rung you don't yet need at the far end, at the rates on offer then.
SSBs can be redeemed at face value in any month. An SGS bond used for a rung should mature on or before the date you need the money. Lesson 8.2, "Match rungs to the dates you need money", shows how to choose the instrument for each rung.
Module 2 showed that bond prices fall when yields rise, and Lesson 2.3, "Duration: how far a price moves when rates move", showed that longer bonds fall more. That price risk is real if you might sell before maturity. A ladder sidesteps it because each rung is held until it matures. At maturity, a bond, bill or deposit pays its full face value, whatever prices did in between. A price dip on a rung you hold to maturity is only on paper and never becomes a loss, because you do not sell.
If rates jump in year two, Wei Ling and Jun Hao's third rung might dip on paper. They never sell it, so they make no loss, and it pays S$15,000 on its date whatever happens to prices. If they had kept 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. A bond fund has no date on which it has to recover from a price fall, and a ladder closes that gap.
The main benefit of a ladder is that timing risk, the danger of needing money just when prices are down, becomes something you have planned around. The money for each bill sits in an instrument that ends before the bill arrives.
Putting the whole sum at one rate, as Jun Hao wants to, is a bet on timing. If rates rise after you lock in, the whole sum is stuck at the lower rate. If rates fall, you come out ahead. Lesson 4.5, "SGS bonds for money with a longer horizon", showed that nobody knows in advance which way rates will move.
A ladder spreads that bet. Each rung locks in the rate for its own term when you place it, and the rungs have different terms. In a rolling ladder, each maturing rung you don't yet need goes back in at the far end at the rates then on offer. Over time you hold a mix of rates set at different times and never commit everything at one moment's rate. You give up the chance of timing rates perfectly, and in return you avoid timing them badly.
Wei Ling and Jun Hao's is a goal ladder, so most rungs will be spent on the bills rather than reinvested, and there is less rate averaging. The dates still line up with the bills. They agree to try the three-rung version.
A ladder is for money with a known date, and 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 described in Lesson 7.3, "When owning the bond beats owning the fund".
A ladder of deposits and bills would keep that money safe from price falls, but it would also grow slowly for decades when it never needed that protection. Over long periods the growth difference becomes large, as Lesson 2.3 of the How money works course, "Estimate doubling time in your head with the rule of 72", shows.
Before you choose a single instrument, write down how a three-rung ladder would work for a sum you need in parts over the next three years.
Pick a sum you will need in parts over the next three years. In three sentences, describe how a three-rung ladder would cover it.
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