NASAA Series 66 Uniform Combined State Law ExaminationClient Investment Recommendations and StrategiesMedium
A client, a 50-year-old professional, is planning for retirement in 15 years. They anticipate needing a steady stream of income during retirement and are concerned about reinvestment risk and interest rate risk for their fixed-income portfolio. Which of the following strategies would best address these concerns?
- AAllocating 100% of their fixed-income portfolio to short-term bond funds.
- BImplementing a bond ladder strategy.
- CPurchasing a diversified portfolio of high-yield corporate bonds.
- DInvesting exclusively in a single long-term zero-coupon bond.
Show answer & explanationAnswer & explanation
Correct answer: B. Implementing a bond ladder strategy.
A bond ladder strategy involves purchasing bonds with staggered maturities. As shorter-term bonds mature, the proceeds are reinvested into longer-term bonds, effectively spreading reinvestment risk over time and mitigating the impact of interest rate fluctuations on the overall portfolio.
Why the other options are wrong
- A. Allocating 100% to short-term bond funds reduces interest rate risk but increases reinvestment risk as all proceeds are reinvested at current rates.
- C. High-yield corporate bonds carry significant credit risk and are not primarily designed to address reinvestment or interest rate risk.
- D. A single long-term zero-coupon bond has significant interest rate risk and concentration risk, and does not address reinvestment risk effectively.
Bond Ladder Strategy
An investment strategy where an investor divides their fixed-income portfolio into several bonds with staggered maturity dates, aiming to reduce reinvestment risk and interest rate risk while providing regular income.
- Bonds mature at regular intervals.
- Reduces reinvestment risk.
- Mitigates interest rate risk.
- Provides predictable cash flow.
Memory trick: A 'Ladder' helps you step up and down interest rates without falling into risk.