A bond ladder is a relatively reliable source of passive income — here's how to build one - Business Insider

, you agree to give the borrower a specific amount of money for a set period of time. During that time frame, they will pay you interest at a mutually agreed-upon annual rate, which is called a coupon rate.

After the first bond reaches maturity, you will have collected all of your interest and gotten back your $10,000. You could keep this money and use it however you wish, while still collecting interest payments on the other nine bonds you own. However, you could also reinvest the cash into another bond that will reach maturity one year after your longest-term bond, which would keep growing your ladder and ensure continued income.

Jessee gives an example of buying $10,000 in bonds with 1% interest and a maturity date of 12 months. If market rates rise to 2% during that time, you could choose to reinvest your proceeds into a new bond at this higher rate. Another positive of building a bond ladder is that your investments are relatively stable. Market rates go up and down, but if you have bonds locked in at a good rate, those changes will only impact you when it comes time for reinvestment. Because you're staggering out maturity dates, you should have cash available within a reasonable time frame should rates go up.

"If you don't have at least $250,000 to $500,000 that you're wanting to invest in the bond portion of your portfolio, then you're probably better off investing in a solid bond mutual fund that can give you broad exposure to the bond market," advises Patterson. "Bonds will fluctuate in market value the opposite direction of interest rates," Jessee explains. "If interest rates go down, then bond values go up . The reason this happens is because if new bonds are paying a lower interest rate than the bond you own, your bond becomes more attractive to potential buyers so the value goes up .", since you risk reinvesting in new bonds with lower rates than when you started.

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