With interest rates soaring this year, you may be considering a foray into the bond market. If you jump in, one decision you’ll have to make is whether to go for short-term or long-term bonds.
There’s a good case to be made now for short-term bonds because they offer higher yields than longer-term bonds. The official term for this dynamic is an “inverted yield curve.”
As of July 19, one-year Treasurys yielded 3.14%, three-year yielded 3.23%, five-year yielded 3.16%, and 10-year yielded 3.01%. So there’s no compelling reason to go beyond three-year maturities.
Less Risky
Short-term bonds carry less risk than long-term bonds because with short-term bonds there is less time for something to go wrong with the issuers. That’s not much of a concern for Treasurys, where the issuer is the U.S. government. But it is for corporate bonds.
Also, short-term bonds obviously will give you your money back more quickly. That could help if an unanticipated spending need arises.
If you’re going to opt for bond funds, Morningstar notes that it’s important to choose one with low fees. The firm compiled a list of the top four short-term-bond exchange-traded and mutual funds. They all have Morningstar’s top rating of gold.
1. Baird Short-Term Bond BSBIX
“The team's no-nonsense approach focuses on investment-grade corporates, high-quality securitized credit, and government bonds,” Morningstar analyst Gabriel Denis wrote in a commentary.
Managers “keep the strategy’s duration [a measure of interest-rate sensitivity] in line with that of the Bloomberg U.S. Government/Credit 1-3 Year Index,” he said. The process forgoes leverage, derivatives, and macro trades, … focusing on security selection and sector rotation.”
2. PGIM Short-Term Corporate Bond PSTQX
“The strategy is atypical for a short-term-bond offering,” Morningstar analyst Eric Jacobson wrote in a commentary.
“It has generally kept its duration between 2.6 and 2.8 years, but that can look long for the peer group, which recently averaged roughly 2 years of duration.”
In addition, “it places an unusually heavy focus on corporate debt -- and associated greater exposure to A and BBB issues,” Jacobson said.
3. Vanguard Short-Term Corporate Bond. Mutual fund: VSTBX, ETF: VCSH
“Focusing strictly on corporate bonds should position this fund to capture market rallies better than most of its Morningstar Category peers without pushing it too far into risky territory," Morningstar analyst Lan Anh Tran wrote in a commentary.
“The majority of its assets are invested in A or BBB rated bonds, while its peers can load up on AAA-rated government bonds instead.”
4. Vanguard Short-Term Treasury. Mutual fund: VSBSX, ETF: VGSH
“This is a conservative portfolio with minimal credit risk, as Treasurys are backed by the full faith and credit of [the] U.S. government,” Morningstar analyst Neal Kosciulek wrote in a commentary.
“Interest-rate risk is the primary driver of its performance, but given its focus on bonds at the short end of the yield curve, even that is muted.”
