For investors with short-term saving goals, short-term bonds can be appropriate investments for your money.
They are stable and they certainly provide a higher return than a money market fund.
However, even with the best short term bond funds, there’s also a risk of losing a percent or two in principal value if interest rates rise.
There are many options available to you, but your best option is to invest in taxable short-term bond funds, U.S. Treasury short-term bond funds and federally tax-free bond funds.
What are short-term bonds?
Short-term bonds, or any bonds for that matter, are debts instruments that companies and the government issue. They typically mature in 1 to 3 years.
When you buy a bond, you are essentially lending money to the issuing company or government agency.
They are obligated to pay back the full purchase price at a particular time, which is called the “maturity date.”
Short-term bonds are low risk investments and you can have access to your money fairly quickly.
As with all bond funds, one of the risk of short term bond funds is that when interest rates rise, the prices of the bonds in the fund decrease.
But short term bond funds have a reduced risk of default, because the bond funds are backed by the full faith and credit of the U.S. government.
Moreover, because the term is short, you will earn less money on it than on an immediate-term or long term bond fund.
Nonetheless, they are still competitive and produce higher returns than money market funds, Certificate of Deposits (CDs), and banks savings accounts. And short-term bonds are more stable in value than stocks.
At a minimum, don’t buy a short-term bond fund if you’re saving for retirement or if you want to hold your money longer.
If you’re looking to invest your money for the long term and are still looking for safety, consider investing in Vanguard index funds.
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Short-term bonds: why do you need to invest in them?
You should invest in short-bonds if you intend to use the money in a few years or so. However, don’t push your emergency cash into bonds. That is what a bank savings account is for.
Also, you should not put too much of your long term investment money into bonds, either. If you have a long term goal for your money, it’s best to invest in mutual funds such as Vanguard mutual funds, real estate, or your own business.
Here are some situations where you should invest in short term bonds.
- You want to stabilize your investment portfolio. If you have other aggressive investments, you may need to balance it out with short term bond funds. The reason is because short term bonds are safer comparing to stocks.
- Buying a house.
- Retirement. If you’re thinking of retiring in a few years, short-term bonds are appropriate.
- Purchasing a car.
- You’re a conservative investor. Not all investors can stomach the risk of losing all of their money due to the market volatility. So instead of investing in stocks, which falls on the riskier end of the securities spectrum, you should invest in short term bond funds.
Best short-term bond funds to consider:
Most people prefer to buy bonds through a broker such as Vanguard or Fidelity.
If you’re looking for the best short-term bond funds to buy now, consider these options:
- Vanguard Short-Term Treasury Index Fund Admiral Shares (VSBSX)
- Vanguard Limited-Term Tax Exempt Fund Investor Shares (VMLTX)
- The Fidelity Short Term Bond Fund (FSHBX)
- Vanguard Short-Term Tax-Exempt Fund Investor Share (VWSTX)
- Vanguard Short-Term Investment Grade fund (VFSTX)
- T. Rowe Price Short-Term Bond Fund (PRWBX)
- Vanguard Short-Term Bond Index Fund (VBIRX)
Tax free short-term bonds
There are some short-term bond funds that are both state and federally tax free. But there are not too many out there.
However, the ones that are available are good investments. So, if you are in a low state bracket and in a high federal bracket, consider investing in these Vanguard bond funds.These are federally tax free bond funds:
Vanguard Limited-Term Tax Exempt Fund Investor Shares (VMLTX)
This Vanguard bond fund seeks to provide investors current income exempt from federal taxes. The fund invests in high-quality short-term municipal bonds.
This bond fund has a maturity of 2 years. So, if you are looking for a fund that provides modest income and is federal tax-exempt, the Vanguard Limited-Term Tax Exempt Fund is for you.
The fund has an expense ratio of 0.17% and a minimum investment of $3,000. This makes it one of the best short term bonds to buy.
Vanguard Short-Term Tax-Exempt Fund Investor Share (VWSTX)
Like the Vanguard Limited Short Term fund, this fund also provides investors with current income that is exempt from federal income taxes.
The majority of the fund invests in municipal bonds in the top three credit ratings categories. It also invests in medium grade quality bonds.
This fund too has an expense ratio of 0.17% and a minimum investment of $3,000, making it one of the best short term bond funds.
U.S Treasury Short-term Bond Funds: Vanguard Short-Term Treasury
If you’re interested in a bond fund that invests in U.S. Treasuries, then U.S.Treasury bond funds are a great choice for you. One of the best U.S.Treasury bond funds is the Vanguard Short-Term Treasury.
This bond fund seeks to track the performance of the Bloomberg Barclays US Treasury 1-3 Year Bond Index. The Vanguard Short-Term Treasury invests in fixed income securities with a maturity between 1 to 3 years.
This bond fund has an expense ratio of 0.07% and an initial minimum investment of $3,000. Currently, this short term bond fund has a 1-year yield of 4.51%, making it one of the best short term bond funds.
Of note, this fund is also available as an ETF, starting at the price of one share.
The Fidelity Short-Term Bond Fund (FSHBX)
The Fidelity Short Term Bond Fund is one of the best out there for those investors who want to preserve their capital. This fund was established in March of 1986 and seeks to provides investors with current income.
The fund managers invests in corporate bonds, U.S. Treasury bonds, and assets backed securities. Over the last 10 years, this bond fund has a yield of 1.98% and a 30-day yield of 1.98%. This Fidelity bond fund as an expense ratio of 0.45%. There is no minimum investment requirement.
Taxable short-term bond funds: Vanguard Short-Term Investment Grade fund (VFSTX)
If you are not in a high tax bracket, then you should consider investing in a taxable short term bond fund. One of the best out there is the Vanguard Short-Term Investment Grade fund.
This bond fund provides investors exposure to high and medium quality investment grade bonds, such as corporate bonds and US government bonds. This fund has an expense ratio of 0.20% and an initial minimum investment of $3,000, making it one of the best short term bond funds out there.
T. Rowe Price Short-Term Bond Fund (PRWBX)
The T. Rowe Price Short-Term Bond Fund invests in diversified portfolio of short term investment-grade corporate, government, asset and mortgage-backed securities. This bond fund also invests in some bank mortgages and foreign securities. This fund produce a higher return than a money market fund, but less return than a long-term bond fund. The T. Rowe Price Short-Term Bond Fund has a minimum investment requirement of $2500, making it one the most favorite short term bond funds out there.
Vanguard Short-Term Bond Index Fund (VBIRX)
The Vanguard Short-Term bond is a good choice for the conservative investor. It offers a low cost, diversified exposure to U.S. investment-grade bonds. This has fund has a maturity date between 1 to 5 years. Moreover, the fund invests about 70% in US government bonds and 30% in corporate bonds. The bond fund as an expense ratio of 0.07% and a minimum investment requirement of $3,000.
How to Invest in Short-Term Bonds
If you’re considering in investing in these or any of Vanguard bond funds, you need to do your due diligence.
First, think about what you need the bond fund in the first place. Is it to diversify your investment portfolio?
Are you a conservative investor who need a minimize risk at all cost? Or, do you want to invest in a short term bond fund because you need the money to use in a few years for a vacation, buying a house, or planning for a wedding?
Once, you have come up with answers to this question, the next step is to do your research about the best bond fund available to you.
Use this list to start. If it’s not enough, do your own research.
Look into how much the initial minimum investment is to buy a bond fund. Most Vanguard short term bond funds require a $3,000 minimum deposit.
Some Fidelity bond funds, however, have a 0$ minimum deposit requirement.
Next compare expense rations, performance for different funds to see if they match your investment goals. But you have to remember that past performance is not an indication of future performance.
Your final step is to open an account to buy your bond funds. If you choose Vanguard, you can do so at their website.
How do you make money with short-term bonds?
You can make money with short-term bonds the same ways you make money with a mutual fund (i.e., dividends, capital gains, and appreciation). But most of your returns in a bond fund comes from dividends.
The bottom line
In brief, short-term bonds are great investment choices if you have short term saving goals. You may be interested in buying these bonds because you expect to tap into your investment within a few years or so. Or, you want a more conservative investment portfolio.
Short term bonds produce higher yields than money market funds.
The only problem is that the share prices can fluctuate. So, if you don’t mind market volatility, you may wish to consider short-term bonds.
Speak with the Right Financial Advisor
- If you have questions beyond short-term bonds, you can talk to a financial advisor who can review your finances and help you reach your goals (whether it is making more money, paying off debt, investing, buying a house, planning for retirement, saving, etc).
- Find one who meets your needs with SmartAsset’s free financial advisor matching service. You answer a few questions and they match you with up to three financial advisors in your area. So, if you want help developing a plan to reach your financial goals, get started now.