In today’s fixed-income market, investors might consider ultra-short bond funds that invest in government, corporate and mortgage debt with average maturities less than a year. Such funds yield more than money market funds, less than short-term bond funds. In addition, credit and interest-rate risk is lower than other bond funds. If interest rates move higher, ultra-short funds will absorb the pain without much principal loss.
Thus, the flexibility and liquidity of ultra-short funds make them good parking places for money you don’t need right away. In essence, ultra-short funds are equivalent to “long-term cash,” a higher-yielding albeit somewhat riskier alternative to money market funds.
Taxable money market funds returned 0.6 percent for the year through February 2004 and 1.6 percent annualized over three years. After tax and inflation, that was a negative return. Ultra-short funds, by comparison, gained 1.9 percent over the past year and 3 percent annualized over three years.
However, high expenses and onerous sales charges can reduce the appeal of many ultra-short funds. Recommended funds in this category are Fidelity Ultra-Short Bond and SSgA Yield Plus; both have high-quality holdings to reduce principal and below-average expenses to maximize returns.