Are Ultra Short-Term Bond Funds a Smart Investment?

The Advantages and Disadvantages of Ultra Short-Term Bond Funds

savings ultra short term bond
If used properly, ultra-short-term bond funds can be a smart investment choice. Getty Images

Investors who are looking to park their money for a few months up to a year may benefit by investing in an ultra short-term bond fund. But before buying, investors should understand the advantages and disadvantages of this fixed income investment type.

What Are Ultra Short-Term Bond Funds?

Ultra Short-term Bond funds, which will typically invest in bonds with durations of less than one year, are a sub category of short-term bond funds, which hold bonds with durations of one to three years.

  Conservative investors tend to like ultra short-term bond funds because they have lower interest rate sensitivity than short-term bond funds but will typically have higher yields than money market funds. However, ultra short-term bond funds have lower relative average returns over time than short-term bond funds and much lower returns than intermediate-term bond funds and long-term bond funds.

Best Time to Buy Ultra Short-Term Bond Funds

As the name implies, ultra short-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 ultra short-term bond fund would do well to average 2%.

However, bond mutual funds have principal risk, which means that an investor can sell a bond fund for a lower value than they bought it. And when interest rates are rising, this risk is increased by a related risk 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, ultra short-term bond funds can be a good idea.

Other than making the potential error in predicting the movement of interest rates, ultra short-term bond funds are best suited for investing over a relatively short period of time, such as three to six months.

Best Ultra Short-Term Bond Funds

Assuming an investor wants to use them as designed and invest for a relatively short period of time, the best ultra short-term bond funds will have no load and will have a low expense ratio.

With expenses in mind, one of the best ultra short-term bond funds to buy is Vanguard Ultra-Short-Term Bond (VUBFX), which has low expense ratio of 0.20% and performance that usually tops most funds with similar holdings.

To find similar funds, investors can research and find the best ultra-short-term bond funds on one of the best websites for researching mutual funds. Just be sure to look for low expense ratios and good historical performance records.

Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.