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What are Short-Term Bond Funds?

Jim B.
By Jim B.
Updated May 17, 2024
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A short-term bond fund is a type of pooled investment vehicle like a mutual fund that concentrates its investments on short-term bonds. These bonds are typically defined as any bond with a maturity date of one to five years. The short maturity dates of the bonds in a short-term bond fund allows for an investment that is relatively low risk and can yield a little higher return than typical money market funds. It is possible for some funds to get involved with risky corporate bonds, which, if they default, could crush the value of those funds.

Most investors have individual goals for the money that they've committed to their investment. Many investors seek diversification, which allows them to benefit from various strategies and mitigate the risk of a few failed investments. In addition, investors are also looking for the chance to grow the capital within their investment. A short-term bond fund can achieve many of these needs for an investor, allowing for a diverse group of investment strategies while still promising a decent rate of return.

As with a mutual fund, a short-term bond fund takes capital from multiple investors who share in the profits and losses of the fund. The fund is managed professionally by a fund company that invests in a variety of short-term bonds. Investors should be aware of the types of bonds in which the fund will invest so that they can make sure the strategies involved are on a par with their needs. All funds must provide a prospectus to investors that outline the investment plans.

Since the maturity dates of the bonds within the fund are relatively small, investors can get in and out of these funds at a quicker rate than other similar funds. Some of these short-term bond funds concentrate on relatively risk-free bonds like those offered by the federal government. Such funds reliably return the investors' capital and offer a slightly better return rate than insured funds like money market funds.

Other funds mix these low-risk bonds with corporate bonds, in which an investor is essentially loaning money to a corporation. These bonds have low bond ratings for their lack of reliability but offer a potentially high yield. Unfortunately, these corporations also run the risk of defaulting on their bond responsibilities due to financial difficulties. If they do, they can send the capital in a short-term bond fund tumbling down with it, damaging all of the investors within the fund.

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