Bottom Line: Shorter maturities protect you against rising interest rates, too.
Over the past several years, investors had little use for short-term bond funds, which provided paltry yields. But now that interest rates are rising, the funds have become an increasingly attractive alternative to long-term bonds and even certain kinds of stocks, which are more likely to be hurt by rising rates. The funds, which typically hold high-quality government and corporate debt with maturities of one to three years, were recently yielding as much as 2.8%. They are most attractive as exchange-traded funds (ETFs), which charge much lower fees than similar mutual funds. How to use them…
As an alternative to blue-chip dividend stocks. If you fear the bull market will end soon, you can trim your exposure to high-quality dividend stocks, which recently had yields in the 2%-to-2.5% range.
As an alternative to intermediate- and long-term bond funds. Yields on longer-term bonds have risen much more slowly than on short-term ones, so there’s little incentive to own them. Example: The ICE US Treasury 20+ Year Bond Index recently yielded just 2.9%.
Warning: Do not use these as a substitute for holding cash, especially if you need to draw on the money soon. Even short-term bond funds carry some risk in the short term. You could see negative total returns if inflation soars and the Federal Reserve has to raise interest rates more aggressively. Recommended short-term bond ETFs now…
Vanguard Short Term Bond ETF (BSV) had a recent yield of 2.8% and an average duration (a measure of interest rate risk) of 2.71, meaning that the fund share price would fall by 2.71% for each one-percentage-point rise in interest rates.
iShares 1-3 Year Treasury Bond ETF (SHY) recently had a 2.4% yield and a duration of 1.94.