The 3 Best Short-Term Bond Funds

When to Buy Short-Term Bond Funds

interest short-term bonds
Find out why and when to buy the best short-term bond funds. Getty Images

With all of the different types of bond funds to choose from, investors can understandably get confused about the best types to buy and what qualities may make them smart additions to a portfolio. For those investors wondering when to buy short-term bond funds, and which ones are the best funds to buy, this article is for you.

The Basic Types of Bond Funds

The fundamental way bonds and bond funds are categorized or identified is by the maturity (or what is usually expressed as "duration"). Another way to describe this categorization is amount of time.

The maturity and duration of a bond may be loosely and simply translated to mean the amount of years of the bond's term. For example, a government, municipality or corporation may issue bonds (loans to be paid back to the buyer in fixed increments) to raise capital (money) for the operations of that issuing entity. The period to pay back the loan (the term) to the bond buyer typically ranges from 90 days all the way up to 30 years. The fixed payments end at maturity (the end of the term or time period).

In the case of bond mutual funds, the bond fund manager buys the individual bonds and the bond fund investor simply buys shares of the bond fund. Most bond funds only buy bonds with maturities within a certain range of time, expressed as the term.

What Are Short-Term Bond Funds?

When you hear or read about short-term bond funds, the reference is usually describing an average duration of the bond fund holdings of one to three years (or a maturity of less than four years).

These bond funds are attractive to fairly conservative investors, because they are less sensitive to interest rates than portfolios with longer durations. This means that, when interest rates are rising, short-term bond funds have less risk of losing value than intermediate-bond funds and long-term bond funds.

Therefore the worst time to buy short-term bond funds is when interest rates are falling. This is when intermediate- and long-term funds tend perform better.

Therefore the best time to buy short-term bond funds is when interest rates are rising or expected to rise in the near future. They can also be smart alternatives to money market funds for investors wanting potential for higher returns for their short-term savings objectives.

The Best Short-Term Bond Funds

The difference in performance between poor to mediocre short-term bond funds and the best short-term bond funds is often much less than 1.00% over a one-year period. Therefore an important quality to look for in this fund category is low expense ratios.

With that backdrop, here are three of the best short-term bond funds to buy:

  1. Vanguard Short-Term Bond Index (VBISX): The rock bottom expense ratio of 0.20% makes VBIRX an outstanding choice for a short-term bond fund. The low expenses have consistently translated in performance that ranks from above-average to top tier. The minimum purchase amount for VBISX is $3,000.
  2. Vanguard Short-Term Investment-Grade (VFSTX):  Again, Vanguard funds offer another top performer because of low expenses. VFSTX is an actively-managed fund that can potentially get higher returns than index funds because of a solid combination of good management and low expenses (0.20%). The minimum initial purchase amount for VFSTX is $3,000.
  1. Fidelity Limited Term Bond (FJRLX): If you plan to hold a short-term bond fund for more than a few years, FJRLX can be a good choice. The longer holding period is suggested because this fund can perform worse than average in bear markets because the fund holds bonds the have below-average credit quality. However this increased risk produces category-beating returns in the long run. The expense ratio for FJRLX is low at 0.46% and the minimum initial purchase is $2,500.

To summarize, be sure the short-term bond funds are a smart choice for you and your investment objectives before purchasing. When used properly, short-term bond funds can make a smart addition to a diversified portfolio of mutual funds.

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.