What Are Short-Term Bonds?

Including bonds in your portfolio can help provide balance, as bonds carry less risk than stocks. But there are a number of different types of bonds to choose from, including short-term bonds, long-term bonds, Treasury bonds, corporate bonds and municipal bonds.

Short-term bonds are bonds that mature in one to four years. When a bond reaches maturity, that means the bond issuer must pay off the bond, or pay back your principal investment or the bond’s face value.

When you cash in a mature bond, you’ll get back your principal investment along with any interest earned during the bond term. Because a bond stops earning interest after it matures, it’s a good idea to redeem the bond when it reaches maturity.

Learn everything you need to know about short-term bonds, including what returns you can expect with them and how to be sure you’re purchasing a safe bond.

Why is one to four years considered short term?

Good question. In some cases, such as determining capital gains taxes on an income-producing investment, more than one year is considered long term.

However, with bonds, the opposite is true. Some long-term bonds can span decades, such as the 30-year Treasury bonds. In comparison, a bond that matures in one to four years is considered short term.

Don’t some bonds have even shorter terms?

Yes, there are some bonds that mature in even less than a year, such as 90-day U.S. Treasury bonds. These are known as ultra-short-term bonds, or as cash equivalents.

For investors who want to have quick access to their money, ultra-short-term bonds may be a good option. Returns for these bonds are usually higher than money market accounts but lower than conventional short-term bonds.

What returns can I expect with short-term bonds?

Shorter terms translate into lower risks for investors. And that usually means lower returns. When everything else is equal, a bond with a longer term to maturity will usually pay a higher interest rate than a shorter-term bond. For example, 30-year U.S. Treasury bonds often pay one or two full percentage points higher than five-year Treasury notes.

That’s because when you buy a bond with a shorter maturity date, your money won’t be tied up as long as with a longer-term bond. With a long-term bond, there is more risk that higher inflation could reduce the value of payments, as well as greater risk that higher overall interest rates could cause the bond’s price to fall.

Because of those additional factors, the returns on bonds aren’t just dependent on the length of time until maturity. Bond returns also are influenced by current interest rates. When interest rates are rising, for instance, short-term bonds usually provide better total returns than their long-term counterparts. When interest rates are falling, longer-term bonds usually provide stronger total returns than short-term bonds.

Are short-term bonds a good investment?

Most successful investors try to diversify their portfolios to include some high-growth (and higher risk) assets, such as stocks, as well as some safer holdings such as cash or bonds, also known as fixed income investments. Short-term bonds, because they are converted back to cash within a relatively short time frame, can work well for the cash or fixed income portion of your portfolio.

If an investor is looking for a conservative investment that will not expose you to much volatility, short-term bonds may be a good option. Also, if interest rates are rising or expected to rise, short-term bonds are even better.

So how much of a well-balanced portfolio should be in bonds? One rule of thumb is to subtract your age from 110. The answer is the percentage of your portfolio that should be invested in stocks, with the remainder in bonds. So if you’re 35 years old, you’d have 75 percent of your investments in stocks, with 25 percent in bonds.

Keep in mind that while bonds are less volatile than stocks, they are not risk-free. If the current interest rates rise during your bond term, the value of your bonds could decline. And if you purchase corporate or municipal bonds and the bond issuer experiences financial problems, the issuer could default on the interest and the principal.

How can I be sure I’m purchasing a safe bond?

As with any investment, buying bonds carries risk. However, you can research the quality of the short-term bonds you’re interested in purchasing before making a decision.

Bonds have ratings, or grades that indicate their quality, to help investors determine whether each bond is a wise investment. Various rating agencies such as Moody’s, Standard and Poor’s, Fitch Ratings and DBRS assign ratings to a firm’s bonds. Those ratings are based on the bond issuer’s financial strength, growth potential and ability to repay its obligations.

U.S. government bonds are backed by the faith and credit of the U.S. government, so they offer the most security and least risk—but they typically pay interest rates that are lower than other short-term bonds. For instance, corporate bonds typically pay the highest interest rates, but the interest is fully taxable. Interest on short-term municipal bonds is exempt from federal income taxes, but the interest rate is usually lower than that of corporate bonds.

How do you purchase short-term bonds?

If you want to purchase short-term U.S. government securities, you can buy them directly from the government by visiting TreasuryDirect.gov. You can also purchase short-term government bonds, corporate bonds and municipal bonds through an investment broker, online or in person.

For most people, the easiest way to invest in short-term bonds is by purchasing bond funds rather than purchasing individual bonds. Bond funds are mutual funds or exchange-traded funds (ETFS) that invest in bonds rather than stocks. (Acorns conservative portfolio contains one of these funds.)

For instance, if you select a mutual fund in the short-term bond category, you purchase shares and instantly own high-quality bond holdings from a variety of issuers, industries and regions. Bond funds are available for purchase through online or in-person brokerage firms, just like purchasing regular mutual funds or stocks.

When you own short-term bonds in a bond fund, you don’t have to worry about cashing in your bonds when they reach maturity. Instead, the fund manager handles that process and reinvests the earnings into more high-rated, short-term bonds, so that investors are constantly invested in short-term bonds. Usually, you can expect a monthly payout of the income earned by the fund.

If you’re interested in adding some stability to your investment portfolio, consider short-term bonds. While they’re not risk-free, they have relatively little volatility and can provide strong returns, especially when interest rates are rising.