Ultra Short-Term Bond Funds

The Advantages and Disadvantages of Ultra Short-Term Bond Funds

save money_wallet
••• Getty Images

Ultra-short-term bond funds can be smart choices for investors who want better potential yields than money market accounts but less market risk than short-term bond funds with longer maturities. 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 typically invest in bonds with a duration of less than one year, are a sub category of short-term bond funds, which hold bonds with a duration of one to three years. Return rates for ultra short-term bond funds are usually higher than money market funds but lower than conventional short-term bond funds.

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 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 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 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, 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.

Put simply, the best time to invest in ultra short-term bond funds is when interest rates are expected to rise. For investors looking for an appropriate objective for investing in ultra short-term bond funds, an appropriate time frame is less than one year.

Best Ultra Short-Term Bond Funds

Assuming an investor wants to use ultra short-term bond funds 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. 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.

Bottom Line

Put simply, ultra-short-term bond funds are best for investment objectives with less than a one-year time horizon. This is because the yields for ultra-short-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 ultra-short-term bond funds when interest rates are rising.

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.