Ultrashort-Term Bond Funds
The Advantages and Disadvantages of Ultrashort-Term Bond Funds
Investors interested in short-term returns have numerous options to consider when looking at the market. Ultrashort-term bond funds can be smart choices for investors who want better potential short-term yields than money market accounts but less market risk than short-term bond funds with longer maturities. Before buying, though, investors should understand the advantages and disadvantages of this fixed-income investment type, along with the best market conditions for investing.
What Are Ultrashort-Term Bond Funds?
Ultrashort-term bond funds, which typically invest in bonds with a duration of less than one year, are a subcategory of short-term bond funds, which hold bonds with a duration of one to three years. Return rates for ultrashort-term bond funds are usually higher than money market funds but lower than conventional short-term bond funds.
Conservative investors tend to like ultrashort-term bond funds because they have less interest-rate sensitivity than short-term bond funds but will typically have higher yields than money market funds. However, ultrashort-term bond funds have lower relative average returns over the long run than short-term bond funds and much lower returns than intermediate-term bond funds and long-term bond funds.
Best Time to Buy Ultrashort-Term Bond Funds
As the name implies, ultrashort-term bond funds are not designed for long-term investing and performance. For example, a total bond market index fund would be expected to average a return of around 5% over a 10-year period, whereas an ultrashort-term bond fund would do well to average 2%.
However, bond mutual funds have principal risk, which means that an investor may potentially sell a bond fund for a lower value than they bought it. And when interest rates are rising, this risk is increased by a market risk type called interest rate risk. So if, in a low-interest-rate environment, an investor wants to get a yield higher than money market funds but interest rates are expected to rise in the near future, ultrashort-term bond funds can be a good idea.
Other than the potential for error in predicting the movement of interest rates, ultrashort-term bond funds are best suited for investing over a relatively short period of time, such as three to six months.
The best time to invest in ultrashort-term bond funds is when interest rates are expected to rise. For investors looking for an appropriate objective for investing in ultrashort-term bond funds, an appropriate time frame is less than one year.
Conversely, if interest rates are currently high or expected to fall, a short-term bond is not as smart of an investment as something with a longer maturity. Long-term bonds are less subject to adverse effects from near-term interest fluctuations.
Best Ultrashort-Term Bond Funds
Assuming an investor wants to use ultrashort-term bond funds as designed and invest for a relatively short period of time, the best ultrashort-term bond funds will have no load and will have a low expense ratio. One of the best ultrashort-term bond funds to buy is Vanguard Ultrashort-Term Bond (VUBFX), which has a low expense ratio of 0.2% and performance that usually tops most funds with similar holdings. The Bloomberg Barclays 1–3 month T-Bill ETF is another great option, with its expense ratio of under 0.14%
To find similar funds, investors can research and find the best ultrashort-term bond funds on one of the many websites for researching mutual funds. Just be sure to look for low expense ratios and good historical performance records.
The Bottom Line
Put simply, ultrashort-term bond funds are best for investment objectives with less than a one-year time horizon. This is because the yields for ultrashort-term bond funds are much lower on average than short-, intermediate-, and long-term bond funds. Because of their low sensitivity to interest rates, some investors like to use ultrashort-term bond funds when interest rates are rising. They may not be a smart investment when interest rates are high and at risk of falling, however.
As with any investment, market conditions at the time of investing should play a significant role in determining your strategy.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.