7 Reasons Why Your Portfolio Needs Short-Term Bond ETFs

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With the Federal Reserve resuming rate cuts, many investors and advisers might be reassessing their short-term liquidity strategies.

Thanks to their stable value, minimal duration and attractive yields, money market funds have become enormously popular in recent years, amassing a record high of $7.5 trillion in assets as of July, according to the SEC.

But money market funds are just one option for managing short-term liquidity needs. Ultra-short and short-term bond ETFs are gaining traction among advisers; ultra-short ETFs are the fastest-growing fixed income ETF category over the past year.

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Ultra-short and short-term ETFs can help investors more precisely manage their liquidity needs.

Here are seven reasons why you should consider them in your portfolio.

1. Lower reinvestment risk than money markets funds

In a falling rate environment, money market funds will reflect declining yields faster.

Because of their slightly longer duration, ultra- and short-term bond ETFs may have lower reinvestment risk — the risk that your options once the bond matures will have lower yields than are available today.

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2. Higher interest rate risk, a positive in the right environment

Bond funds have higher interest rate risk than money market funds, but this can benefit investors when rates fall, boosting bond prices.

It's important for investors and advisers to carefully weigh how anticipated changes in monetary policy and yield curves can affect the relative attractiveness of short-term bond ETFs vs money market funds.

Some professionals see ultra-short bond ETFs as alternatives to money market funds for immediate needs given their comparable duration profile, while short-term bond ETFs complement money market funds for longer-term savings goals. Consider each in the perspective of an overall portfolio.

3. Historically higher risk-adjusted returns

Ultra-short and short-term bonds have typically provided higher returns than bank accounts, money market funds and CDs because of their slightly longer maturities, though with modestly higher volatility.

This trend may persist with a normalizing yield curve.

ETFs also provide on-demand liquidity during market hours, comparable to money market funds and bank accounts, and avoid the lock-up periods of CDs.

4. Tax efficiencies

ETFs can be more tax-efficient than traditional mutual funds because in-kind transfers help minimize capital gains distributions.

However, overall tax treatment depends on the securities held, not just the ETF structure.

For example, money market funds do not distribute capital gains, and tax-exempt income depends on the underlying assets.

5. Lower costs

ETFs generally have lower average expense ratios than their mutual fund peers, but are subject to premium/discount volatility and bid-ask spreads. Investing with a large, reputable ETF issuer can help reduce total cost of ownership.

6. More customization and flexibility

There are ETFs for just about any duration, credit quality or sector. A portfolio of ETFs can be tailored to meet a client's goals, risk profile, tax strategies and tiered spending needs.

7. Accessibility

Unlike bank products or mutual funds, ETFs are available to anyone with a brokerage account with no investment minimums.

The right tools for the right time horizon

Cash and liquidity management is a function of risk tolerance, time horizon and spending needs. Having a framework in place can ensure clients have the optimal amount of cash in their portfolio.

Immediate spending needs within three months or less. Assets needed this soon should be in money market funds or possibly ultra-short ETFs invested in Treasury bills or other securities with maturities of 90 days or less.

Upcoming expenses up to a year. Ultra-short ETFs with an average duration of less than one year might be more appropriate for this time horizon.

Planned expenses from one to two years. Short-term bond ETFs become more viable for this time horizon, depending on the client's financial situation and comfort level.

Investors and advisers should evaluate liquidity tools not just by yield, but by strategic fit within the broader portfolio. Money market funds offer safety for immediate needs, while short-term ETFs provide dynamic solutions for those seeking higher returns and greater flexibility as rates decline and market conditions evolve.

For many clients, the optimal approach will involve blending both vehicles, ensuring they have the right liquidity resources over different time horizons.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Brad Collins is a Fixed Income Product Manager, responsible for developing and supporting Vanguard's robust fixed income product ecosystem. In this role, Brad interfaces with investment teams and sales to deliver a superior client product experience. Prior to joining the Fixed Income Product team in January 2025, Brad spent four years as a senior fixed income trader on Vanguard's Active Credit team.