What Is the Bullet Bond Strategy?
Definition & Examples of the Bullet Bond Strategy
The bullet bond strategy is a bond investing strategy in which an investor buys bonds that all mature at the same time. A bullet strategy is one of three popular approaches to constructing a portfolio of individual bonds; the other two are the ladder and barbell strategies.
Learn details about this strategy and examples of how you can work it into your investment portfolio.
What Is the Bullet Bond Strategy?
An investor who uses a bullet strategy purchases several bonds that mature at the same time. By targeting this specific maturity date, the investor aims to invest in a particular segment of the yield curve. That's where the term “bullet” comes from—it's an attempt to hit a specific point in the yield curve.
Although all of the bonds held in a bullet strategy portfolio bullet mature at the same time, they are all purchased at different times—usually years apart.
How Does the Bullet Bond Strategy Work?
By purchasing at different times, the bullet strategy leverages diversification to reduce the impact of interest-rate fluctuations. For instance, an investor following the bullet bond strategy might buy a 10-year bond in a given year, and then three years later, they buy a seven-year bond.
If rates rise between the first purchase and the second, then the investor will earn a higher rate than if they had invested the entire portfolio in the first year. Rates could also fall during that three-year period, but the primary goal of staggering the purchases is to “hedge,” or protect, against the possibility rates could rise sharply in a given year.
The bullet bond strategy might be better defined as a defensive strategy, rather than an offensive one. An investor following this strategy won't necessarily beat the investor who buys a single bond. Instead of trying to beat another investor, the bullet bond investor seeks to assure the return of principal while protecting themself (to a certain extent) from interest rate risk.
Planning for Future Expenses
The bullet bond strategy works especially well for investors who are planning for an expense in the future. For example, an investor might plan on their child heading to college in 2030. This investor wants to keep the principal safe, so they choose to invest in bonds rather than stocks, and they decide to use a bullet strategy. They land on a bullet strategy that includes five investments in five different years: 2020, 2022, 2024, 2026, and 2028. In each of these years, the bonds bought all share the same maturity date in 2030.
Benefits of the Bullet Bond Strategy
Consider these two benefits to the bullet bond strategy:
- The investor doesn't need to have all the cash they plan to invest right away. In the example of an investor preparing for their child to go to college, the purchases take place over eight years. That gives the investor plenty of time between purchases to save up the cash for the next bond investment.
- Selecting a maturity date that coincides with a major expense (in the example, this is expense is college) ensures that the investor's family will have cash when they need it most.
As with all bond strategies, a bullet bond investor faces a certain level of credit risk. If you buy a bond from an entity that goes bankrupt, that entity could fail to honor the terms of the bond. This risk increases for those who invest in lower-grade corporate bonds. The tradeoff is that lower-grade bonds often offer higher interest rates.
Benefits Over Bond Funds
The bullet bond strategy shares similar concepts with the other two major bond investing strategies. All three strategies attempt to reduce yield volatility and risk, though each pursues this goal in its own way. All three depend upon the strategic reinvestment of the proceeds from matured bonds.
While each bond strategy inevitably poses a risk (as do all investments), all three avoid some traps posed by bond funds, including secondary market trading and consistent reinvestment of mature bonds.
The downsides to bond funds effectively remove the offer of a known maturity date—a date when the investor gets back at least their principal. With a bond fund, you can lose the money you've invested.
Individual bond strategies, as opposed to bond fund investment, hold a finite number of bonds, each of which has a known maturity date. Consequently, in most cases, you can hold your bonds to maturity and eventually get your return of principal.
- The bullet bond strategy is a bond investment strategy in which bonds with the same maturity date are bought over a period of several years.
- The bullet bond strategy is one of three major bond investment strategies. The others are ladder and barbell strategies.
- The bullet bond strategy works best when you have a specific expense in the future that you'd like to prepare for, such as sending a child to college.