Best Mutual Funds for Short-Term Investing

There are options for short-term investments, but some are riskier than others

An investor looks over her money market fund.

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One of the first lessons conveyed to new investors is that stock mutual funds, and to some extent bond mutual funds, should be viewed as long-term investments. This means that money you might need within three to five years should not be invested in stock mutual funds or long-term bond funds.

However, some mutual funds are appropriate for short-term investing. Learn the types of funds that can provide some return on investment while keeping the principal amount you invest relatively safe.

Key Takeaways

  • Short-term investing involves assets with a three- to five-year maturity. 
  • Money market funds are an example of a short-term investment that started during the 1970s, and some funds are tax-exempt. 
  • Ultra-short-term bond funds typically pay the investor back in less than 12 months. 
  • Several short-term mutual funds have averaged 2% returns over the past three years.

What Is Short-Term Investing?

Short-term investing involves a financial investment that can be easily converted to cash, typically within a three-to-five-year timeframe. Many investors seek better short-term investment options than a savings account or a certificate of deposit (CD). The national average interest rate for savings accounts in mid-April 2021 was just 0.06% for balances of $2,500. The interest rate for a 12-month $10,000 CD was 0.14%, according to the Federal Deposit Insurance Corporation (FDIC).

One common parking place for short-term investments is a money market mutual fund. There are many types of money market funds. They generally limit risk by choosing to invest in high-quality bonds, short-term government bonds, tax-exempt municipal bonds, and corporate and bank securities.

If you’re new to investing, reaching out to a financial advisor can be a good first step for formulating a strategy that suits you.

The Best Mutual Funds for Short-Term Investing

Some bond funds provide a fairly safe short-term investment while offering higher yields and returns than money-market mutual funds or other short-term products. Here’s a closer look at the types of funds that work well for short-term investing.

Money Market Funds

Money market funds were created during the 1970s. They were designed as an option for investors to purchase a pool of securities that often provide higher returns than interest-bearing bank accounts. Some money market funds are meant for retail investors. Funds that require a high-value minimum investment are designed for institutional investors.

Money market funds are not the same as the money market accounts that are offered by banks. Money market accounts are insured by the FDIC, but money market funds are not.

Money market mutual funds can be split into three groups:

  • Prime money market funds: These invest mostly in high-quality, short-term private debt securities.
  • Government money market funds: These invest 99.5% or more of their total assets in very liquid investments, including cash and government securities.
  • Tax-free money market funds: These invest only in securities issued by state and local governments and are tax-exempt.

Ultra-Short Bond Funds

Ultra-short bond funds invest in fixed-income securities that pay you back after less than a year. These funds may invest in a wide range of securities, including corporate debt, government securities, and mortgage-backed securities.

Investors should be aware that ultra-short bond funds have a higher risk than money market funds and CDs. 

A Morningstar review of ultra-short bond funds includes a handful of funds that report a 12-month yield over 2% (as of May 2021). These include:

  • BBH Limited Duration Fund (BBBIX): This fund boasts a three-year annual average return of 3.2%. It invests in fixed-income instruments such as asset-backed securities. It also invests in notes and bonds issued by domestic and foreign companies, the U.S. government, government agencies, and government-guaranteed issuers.
  • DoubleLine Low Duration Bond I (DBLSX): The fund has an average annual return of 2.81% over three years. It typically has at least 80% of its net assets in bonds. The fund may, however, invest up to 50% of its total assets in fixed income and other assets that are rated below investment grade or which are ungraded but of similar credit quality.
  • William Blair Low Duration R6 (WBLJX): The fund had an annual average return of 2.50% from 2018 to 2020. It invests mostly in investment-grade debt securities rated in the highest three categories by at least one nationally recognized rating group.

Short-Term Bond Funds

Short-term bond funds invest in bonds that mature in one to three years and offer high liquidity. These bonds have a low interest-rate risk compared to bonds with longer terms, which allows them to weather adverse market conditions. However, you can lose your principal with short-term bond funds.

Short-term bond funds that are highly rated by Morningstar include, as of May 4, 2021:

  • Vanguard Short-Term Corporate Bond Index Fund Admiral Shares (VSCSX): This fund had a three-year annual average return of 4.30% before taxes. The fund employs an indexing investment approach designed to track the performance of the Bloomberg US 1-5 Year Corporate Bond Index. This index includes securities issued by industrial, utility, and financial companies, all with maturities between one and five years.
  • PGIM Short-Term Corporate Bond Fund Class Z (PIFZX): This fund also had a three-year annual average return of 4.30% before taxes. In normal times, the fund invests at least 80% of its assets in corporate bonds. Bonds include all fixed-income securities other than preferred stock. The effective time frame of the fund's portfolio is typically less than three years.
  • Baird Short-Term Bond Fund Institutional Class (BSBIX): The fund had a three-year annual average return of 3.52% before taxes. It invests at least 80% of its net assets in a number of U.S. and foreign entities. It only invests in debt obligations rated investment grade at the time of purchase by at least one major rating agency or, if unrated, deemed by the advisor to be investment grade.

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.