While bond funds are frequently lumped together in investment literature as a monolithic group, there are many different types of funds that can help investors achieve a variety of goals. The safety of a bond fund's principal is one of the most important goals for many investors. Short-term bond funds may be appropriate for you if you need to prioritize capital preservation. However, keep in mind that these funds are unlikely to provide much in the way of income.
Main Points
- A short-term bond fund invests in bonds with a maturity of fewer than five years.
- Although interest rate risk is lower in short-term bonds than in intermediate- or long-term bonds, you can still lose your principal.
- In the bond market, risk and yield usually go hand in hand, so these lower-risk bond funds have low yields.
- Short-term bond funds have higher yields than money market funds, making them a good choice for investors with a slightly longer time horizon.
A Short-Term Bond Fund is defined as
A short-term bond fund invests in bonds that mature in less than five years. All issues of short-term debt can be addressed by governments, businesses, and companies rated below investment grade.Risk and Return
Short-term bonds in this category have a lower interest rate risk than intermediate- or long-term bonds, so they hold up better in volatile markets. A short-term bond fund can lose its principal, regardless of how low the risk is. For example, the bond market performed poorly in the second quarter of 2013. The Vanguard Short-Term Bond (BSV) exchange-traded fund (ETF) fell -0.78 percent during that time. Despite the drop, it outperformed the Vanguard Intermediate-Term Bond ETF (BIV) by -4.02 percent and the Vanguard Long-Term Bond ETF by -6.07 percent (BLV). As a result, while short-term bonds suffered losses, they were minor in comparison to other maturity segments. On the other hand, short-term bond funds do not participate in the bond market's upside (value growth) to the same extent as long-term bond funds. It's important to remember that not all short-term bond funds are created equal. Some funds invest in higher-risk securities, such as high-yield bonds to offset the low-yield environment. In comparison, others may seek to offset the low-yield environment by investing in higher-risk securities. Check a fund's recent daily fluctuations in comparison to its peers before purchasing it. If it has higher-than-average volatility, it may not provide the same level of safety as short-term bond funds. Important: Short-term bond funds can contain a variety of risky securities and bonds. As a result, each one performs differently, so make sure to evaluate any short-term bonds you're considering thoroughly. Another factor to consider is that these funds have low yields because they are on the lower risk end of the risk-to-return spectrum. In the bond market, risk and yield typically go hand in hand. The yields may not be sufficient to compensate for inflation in several cases. Low yields, on the other hand, are the cost of achieving a higher level of safety for investors.Money Market Funds vs. Short-Term Bond Funds
Short-term bonds are typically thought of as the riskier alternative to money market funds. Short-term bond funds have minimal share price fluctuation, whereas money market funds can maintain a stable $1 share price. Short-term bond funds provide higher yields than money market funds in exchange for a slightly higher risk. As a result, short-term funds may be a good choice for investors with a slightly longer investment horizon (the amount of time an investment is expected to be held), such as two to three years, who are willing to take on a little more risk in exchange for a higher yield.Short-Term Bond Funds: Why Should You Consider Them?
Short-term bond funds will not make you wealthy. They can, however, be used for a variety of purposes:- Bond funds can be a good alternative to the current low-yielding options.
- They can be used to store the needed cash for the next two to three years.
- Short-term bond funds let investors who are concerned about a potential bond bear market keep their money in the market while reducing their risk.
- They have a long track record of providing a higher return ratio in exchange for the risks associated with long-term bonds.
- They are less affected by inflation than intermediate and long-term bonds.
- Bond funds are highly liquid, allowing investors to access their money quickly.
Short-Term Bond Funds: How to Invest
In the short-term bond fund category, investors have a plethora of options. Investors can buy short-term bond ETFs in addition to bond funds. Investors typically purchase short-term bond funds through investment brokers.