Ultrashort-Bond Funds and Short-Term Municipal Bond Funds

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Ultrashort-Bond Funds and Short-Term Municipal Bond Funds

Ultrashort-bond funds

Ultrashort-bond funds invest mainly in Treasury, mortgage-backed, and corporate bonds. They limit risk by sticking with short-term securities. With an average duration of just six months, they don’t feel much pain when interest rates rise. Money markets, by contrast, carry durations near zero, but offer lower returns.

If you don’t want to put your principal at risk, but would like to eke out a little more return, ultrashort funds are a good first step away from money market funds.

Some funds dip into lower-quality bonds for their higher yields, though. Such funds look safer than they are, because bond defaults have been few and far between in recent years.

Short-term municipal bond funds

Short-term municipal bond funds, or munis, buy slightly longer-term securities than ultrashort bond funds do.

Because they carry longer durations, short-term muni funds are more sensitive to interest rate shifts than ultrashort funds. Therefore, they gain more than ultrashort funds when interest rates drop.

Buying an insured muni fund won’t lessen the interest rate risk. While insurance protects against defaults, it can make funds even more vulnerable to rate changes.

If you’re saving for a home or another longer-term goal and you can weather some rougher patches, short-term muni funds fill the bill—especially if you’re in a high federal-tax bracket. That’s because these funds only buy municipal bonds, whose interest is exempt from federal income taxes.