Using a bond ladder strategy can help investors strike this balance. A bond ladder is a portfolio of bonds of similar amounts that mature in several different years. For instance, a $100,000 portfolio might consist of 10 different bonds of $10,000 each, maturing in 10 consecutive years. When a bond matures, the principal is reinvested in another bond at the bond ladder's longest maturity date (10 years in this example).

By spreading out maturity dates, the effects of interest rate changes are lessened. Since the bonds are held until maturity, changing interest rates don't result in a gain or loss from a sale. Bonds are maturing every year or two, so your principal is reinvested over a period of time instead of in one lump sum. If interest rates rise, you have principal coming due every year or so to reinvest at the higher rates. In a declining interest rate environment, you have some funds in longer-term bonds with higher interest rates. A bond ladder keeps your bond portfolio invested in a range of maturity dates, evening out your interest income over time.

One of the main advantages of this strategy is that you don't just hold short-term bonds, waiting to determine the future direction of interest rates. Your funds are always invested in a variety of maturities.

When designing a bond ladder, decide on an average maturity date, which could be five, 10, or even 20 years, depending on your financial needs. There should be enough "rungs" on the ladder for principal to mature every year or two. If the rungs mature in longer than two-year increments, you might miss interest rate changes. Consistently follow your plan by automatically reinvesting principal at the longest maturity date.

You can also set maturity dates in your ladder to coincide with a specific financial need. For instance, a bond ladder might mature in each of four consecutive years while your child is in college, allowing you to pay college costs with maturing principal.