Bonds #16: Matching scheduled cash needs

In the last two weeks, we looked at structuring a bond portfolio that was intended either as a:

savings vehicle or

source of steady income.

A ladder structure of maturity dates would help avoid a great amount of reinvestment risk.

A ladder of coupon payment dates would provide a steady amount of income over the course of a year.

But what if you know that you must plan to take some of your money OUT of your portfolio?

This could be for many purposes. Part of your savings could be earmarked for:

A wedding

Eight semesters of college tuition

Vacation trips every second year

New car every five years

Annual gifts as part of estate planning

Payments to yourself for retirement living.

In these cases, you could buy a bond with a maturity date that will approximate the date of your cash flow need.

In the meantime, of course you will be receiving interest from that bond (or series of bonds) that you will need to reinvest.

One way to simplify the process is to buy zero-coupon bonds with maturity dates that match your future needs.

In an earlier article, we discussed the usefulness of ‘zeros’, but the main characteristic is obvious – there is no coupon paid. You have no interest payments to reinvest between purchase date and maturity date (at yields that may be higher or lower than today’s).

Offsetting this lack of cash flow is an appealing price.

Zero coupon bonds are sold at a deep discount.

Looking at my screens today, I see that a 20-year Treasury bond that could help with your favorite newborn’s first car, wedding or college payment will cost you about 30 cents on the dollar.

If you spent $3,000, you would get back $10,000 in 20 years, government guaranteed. That’s a return of 6.23% for the period.

If you were looking to receive your principal back sooner, then a 10-year Treasury bond with a similar yield of about 6 ¼% would cost about 55 cents on the dollar. This means you could buy a $1,000 Treasury bond for about $550.

If, instead of a Treasury, you bought a zero-coupon 10-year corporate bond at a higher yield, possibly near 7½%, the price would be even lower. It would not be government guaranteed, but you would check that the credit rating was at least investment-grade, maybe single A or AA.