Investing Assets & Markets Bonds Short-Term Bond Funds What You Should Know About Short-Term Bond Funds By Thomas Kenny Updated on March 4, 2021 Reviewed by Robert C. Kelly Reviewed by Robert C. Kelly Robert Kelly is managing director of XTS Energy LLC, and has more than three decades of experience as a business executive. He is a professor of economics and has raised more than $4.5 billion in investment capital. learn about our financial review board Sponsored by What's this? & In This Article View All In This Article Definition Risk and Yield Short-Term vs. Money Market Reasons to Consider How to Invest Photo: Chris Cheadle / Getty Images While bond funds are often lumped together as a monolithic group in investment literature, there are in fact a wide variety of funds that can help investors meet a broad range of objectives. One of the most important goals of many bond-fund shareholders is the safety of their principal. If you count yourself among those who need to prioritize capital preservation, short-term bond funds may be right for you. Keep in mind, however, that these funds are unlikely to offer much in the way of yield. Key Takeaways A short-term bond fund invests in bonds with maturities of less than five years.Short-term bonds tend to have lower interest rate risk than intermediate- or long-term bonds, but it is still possible to lose your principal.Risk and yield typically go hand-in-hand in the bond market, so these lower-risk bond funds offer low yields. Short-term bond funds offer higher yields than money market funds, making them a good choice for those with a slightly longer investment horizon. Definition of a Short-Term Bond Fund A short-term bond fund is a fund that invests in bonds with maturities of less than five years. Any entity can issue short-term debt, including governments, corporations, and companies rated below investment grade. Risk and Yield Short-term bonds in this category tend to have lower interest rate risk than either intermediate- or long-term bonds, so they tend to hold up better when market conditions are unfavorable. Regardless of the low risk, it is possible to lose your principal in a short-term bond fund. For example, in the second quarter of 2013, the bond market performed very poorly. During that time, Vanguard Short-Term Bond (BSV) exchange-traded fund (ETF) fell -0.78%. Even with this fall, it vastly outperformed the -4.02% return of Vanguard Intermediate-Term Bond ETF (BIV) and the -6.07% return of Vanguard Long-Term Bond ETF (BLV). Therefore, while short-term bonds fell, their losses were mild compared to other maturity segments. However, short-term bond funds don’t participate in the bond-market upside (growth in value) to the same extent as long-term funds. Note that not all short-term bond funds are created equal. Some funds invest in securities with higher credit risk, such as high-yield bonds, while others may seek to offset the low-yield environment by venturing into higher-risk securities. Before buying a fund, be sure to check its recent daily fluctuations relative to its peers. If it exhibits above-average volatility, that’s an indication that it may not offer the safety typically associated with short-term bond funds. Note Short-term bond funds can be mixed with various risk securities and bonds. This makes them all perform differently, so be sure to thoroughly assess any short-term bonds you are considering. Another consideration is that these funds, by virtue of their location on the lower-risk end of the risk-to-return spectrum, offer low yields. Note that risk and yield typically go hand-in-hand in the bond market. In many cases, the yields may not be sufficient to overcome the impact of inflation. However, low yields are the price investors pay for achieving a greater degree of safety. Short-Term Bond Funds vs. Money Market Funds Short-term bonds are typically considered to be the next rung up the risk ladder from money market funds. Whereas short-term bond funds have modest share price fluctuation, money market funds can maintain a stable $1 share price. In exchange for the slightly higher risk, short-term bond funds offer higher yields than money market funds. For this reason, short-term funds can be an option for those with a slightly longer investment horizon (the amount of time an investment is expected to be held), such as two to three years, that allows them to take on a modest degree of risk in exchange for a higher yield. Reasons to Consider Short-Term Bond Funds Short-term bond funds aren’t going to make anyone rich. However, they can serve several purposes: Bond funds can act as an alternative to the various options that currently offer low yields. They can be used as a place to store cash that won’t be needed for another two to three years. Short-term bond funds allow investors who are concerned about a possible bear market in bonds to stay invested in the bond market at a lower degree of risk. They have a strong historical record of providing a better ratio of return in exchange for the attendant risks of long-term bonds. They are less sensitive to rising inflation than intermediate- and long-term bonds. Bond funds are highly liquid, which means they offer investors easier access to their capital. How to Invest in Short-Term Bond Funds Investors have countless options in the short-term bond fund category. In addition to bond funds, investors can also purchase short-term bond ETFs. Investment brokers are generally where investors go to purchase short-term bond funds. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Vanguard. "Short-Term Bond ETF (BSV)." Vanguard. "Intermediate-Term Bond ETF." Vanguard. "Long-Term Bond ETF."