Two Bond Funds, Two Very Different Rides

Short-term bond ETFs hold bonds that mature within about one to three years, so their prices barely move when interest rates change. Long-term bond ETFs hold bonds that mature in ten, twenty or thirty years, so their prices can rise or fall as sharply as stocks when rates move. Long-term funds usually pay more income in exchange for that extra risk, although not always.

The right choice depends mainly on when you will need the money. Money needed in the next few years usually suits a short-term fund, while money you will not touch for a decade or more can carry the bigger swings of a long-term fund. Many investors hold both, or use an intermediate fund that sits in between.

Don’t start investing and then start learning how investing works. FRC’s three ETF programmes, ETF Investing for Beginners, ETF Investing Strategies and Advanced ETF Investing, explain how bond funds behave and how to match them to your goals before you put money in. They are written in plain English, need no finance degree, and are open to everyone.

This guide is part of FRC’s complete step-by-step guide to investing in ETFs. It compares short-term and long-term bond ETFs on risk, income, interest rate sensitivity and tax, so you can decide which belongs in your portfolio.

Short-Term vs Long-Term Bond ETFs at a Glance

Duration is the biggest difference. Short-term bond ETFs typically have durations of around two years or less, while long-term Treasury ETFs typically have durations of around 15 years or more. That single number tells you how far each fund’s price is likely to move when interest rates change.

Price swings follow from duration. Short-term funds usually move only a little in a year, while long-term funds can rise or fall by double digits. When rates rise, short-term funds dip slightly and recover quickly through higher income, while long-term funds can suffer stock-like losses that take years to earn back.

Income usually favours long-term funds, because investors are paid more for lending for longer. That is not guaranteed: when short-term rates are high, short-term funds can pay as much or more. Falling rates favour long-term funds, which can rally sharply as investors seek safety, while short-term funds gain only a little.

Neither type matures. Both are open-ended funds that keep rolling their bonds to hold a steady maturity range, so neither guarantees your money back on a fixed date. That is the key difference from holding an individual bond to maturity.

How Bond ETFs Are Sorted by Maturity

Every bond has a maturity date, the day the issuer repays the full face value. Bond ETFs are usually grouped by the average time their bonds have left until that date. The labels vary slightly between fund providers, but the broad bands are consistent.

Ultra-short bond ETFs hold bonds maturing within about a year. Short-term funds generally hold bonds maturing in one to three or one to five years. Intermediate funds usually hold bonds maturing in three to ten years, and long-term funds hold bonds maturing in ten years or more, often twenty years or more for long-term Treasury funds.

Most bond ETFs never mature themselves. A short-term Treasury fund, for example, sells bonds as they fall below one year to maturity and buys new two- and three-year bonds to replace them. That keeps the fund’s profile roughly the same year after year, which is why a short-term fund stays short-term indefinitely.

What Short-Term Bond ETFs Offer

The main appeal of a short-term bond ETF is stability. Because its bonds are repaid within a few years, a change in interest rates only affects them for a short time, so the fund’s price moves very little. In most years, a short-term Treasury fund’s price changes by only a few percent at most.

Short-term funds also adjust quickly when rates change. Their bonds mature and are replaced so often that their yield catches up with market rates within a year or two. When the Federal Reserve raises rates, short-term fund investors start earning more income almost immediately.

The trade-off is that short-term funds usually pay less than long-term funds in normal conditions, and they gain little when rates fall. If rates are cut sharply, a short-term fund’s income drops quickly too, because the bonds it buys to replace maturing ones pay less.

Popular short-term funds include broad short-term Treasury ETFs such as SHY, SCHO and VGSH, and short-term investment-grade bond funds such as BSV, which also hold high-quality corporate bonds.

Even shorter options exist. Treasury bill ETFs and ultra-short bond ETFs hold securities maturing within months, so their prices barely move at all. Floating-rate bond ETFs hold bonds whose interest payments reset with market rates, which keeps their duration close to zero, although corporate floating-rate funds still carry credit risk.

A short-term fund can still show a loss. If rates rise, the bonds it holds fall a little in value, and an investor who sells before the higher income has made that up locks in the small loss. The fund recovers by holding on, not by maturing.

What Long-Term Bond ETFs Offer

Long-term bond ETFs lock in interest rates for many years. When rates fall, that becomes very valuable, and their prices can rise sharply. In a recession or a stock market crash, long-term Treasury funds have historically been among the best-performing assets, because investors rush to safety and expect interest rates to be cut.

They also usually pay higher income than short-term funds. Investors demand extra yield for tying their money up for longer and accepting bigger price swings, an extra return sometimes called the term premium.

The trade-off is volatility. A long-term Treasury fund can fall by 10%, 20% or more when rates rise, and recovering that loss can take years. For an investor who needs the money soon, that makes long-term funds a poor fit, however safe the underlying government bonds may be.

Popular long-term funds include long-term Treasury ETFs such as TLT, VGLT and SPTL, and long-term bond funds that also hold corporate bonds, such as BLV.

Don’t pay the market to teach you expensive lessons. ETF Investing for Beginners explains how bond funds work, how maturity changes their risk and where each type fits in a portfolio.

Duration: Where the Difference Really Shows

The clearest way to compare short-term and long-term bond ETFs is duration. Duration measures how sensitive a bond fund is to interest rate changes, and as a rule of thumb, a fund’s price moves about 1% in the opposite direction for each year of duration when rates change by one percentage point.

A short-term Treasury fund typically has a duration of around two years or less, so a one-point rise in rates would be expected to cut its price by about 2%. A long-term Treasury fund holding bonds of twenty years or more typically has a duration of around 15 years or more, so the same rise could cut its price by around 15% or more.

That gap is the whole story of short-term vs long-term bond ETFs in a single number. The same rate move that causes a small dip in one fund can cause a stock-like loss in the other. Every bond ETF publishes its duration on its fact sheet, and it is worth checking before you buy.

FRC’s guide on how bond ETF prices respond to interest rate changes explains duration in more detail, with a worked example. FRC’s guide to Macaulay duration vs modified duration covers the different ways it is measured.

A Simple Example

Imagine putting $10,000 into a short-term Treasury ETF with a duration of two years and another $10,000 into a long-term Treasury ETF with a duration of 15 years. Interest rates then rise by one percentage point across the board.

The short-term fund would be expected to fall by about $200, to around $9,800. Because its bonds mature quickly, its yield would rise within a year or two, and the extra income would make up that small loss in around two years.

The long-term fund would be expected to fall by about $1,500, to around $8,500. Its yield would also rise, but much more slowly, because its bonds take decades to mature. Recovering the loss through higher income could take around 15 years if rates stayed at their new level.

Now reverse it. If rates fall by one percentage point, the short-term fund gains about $200 and the long-term fund gains about $1,500. That is the bet a long-term bond investor is making, whether they realise it or not.

How the Two Have Behaved in Real Markets

The history of short-term and long-term Treasury funds shows how differently they can behave. In 2008, during the global financial crisis, long-term Treasury ETFs gained more than 30% as investors fled to safety and rates fell. Short-term Treasury funds gained only a few percent, but they also held steady.

In 2020, as the pandemic hit, long-term Treasury funds again rose sharply, gaining around 18% for the year as rates fell to record lows. Short-term funds gained only modestly, because their yields were already close to zero.

In 2022, the picture reversed. The Federal Reserve raised rates rapidly to fight inflation, and long-term Treasury ETFs fell around 30% in a single year, a loss as deep as the stock market’s. Short-term Treasury funds fell only around 4%. Including the declines of 2021 and 2023, the price of the best-known long-term Treasury ETF fell close to half from its 2020 peak.

The lesson is not that one type is better. Long-term funds can be excellent shock absorbers when rates fall, and painful when rates rise. Short-term funds give up most of that upside in exchange for stability.

The market doesn’t care whether you understand the risks. It will expose you to them regardless. ETF Investing Strategies shows you how to match bond fund duration to your time horizon, so a move in interest rates never catches you off guard.

Which Pays More Income?

In most periods, long-term bond ETFs pay higher yields than short-term ones. When the yield curve slopes upward, as it does most of the time, investors are paid more for lending for longer. That higher yield is the reward for accepting more price risk.

The gap is not fixed, though, and it can disappear. When the Federal Reserve raises short-term rates quickly, short-term yields can climb above long-term yields. This is called an inverted yield curve, and it happened for much of 2023 and 2024, when short-term Treasury funds paid more than long-term ones.

In those conditions, investors in short-term funds earned more income while taking less risk. Investors in long-term funds were effectively betting that rates would eventually fall and lift the prices of their bonds. FRC’s guide to the normal vs inverted yield curve explains how the shape of the curve affects bonds of different maturities.

Income also changes at different speeds. A short-term fund’s yield follows market rates quickly, up and down. A long-term fund’s yield changes more slowly, because most of its bonds were bought years earlier. When rates are being cut, a long-term fund can keep paying higher income for longer.

Reinvestment Risk: The Hidden Cost of Short-Term Funds

Short-term bond funds have a risk of their own, called reinvestment risk. Because their bonds mature so quickly, they constantly reinvest at whatever rates are on offer. If rates fall, the fund’s income falls with them within a year or two.

That matters most to investors who rely on bond income to live on. A retiree drawing income from a short-term fund in a period of falling rates may see their income drop sharply, while a long-term fund would keep paying the higher rates it locked in years earlier.

Long-term funds face the opposite problem, called interest rate risk or price risk. Every bond investor faces one or the other. The question is which risk you can live with more comfortably.

Intermediate Bond ETFs: The Middle Ground

Between short-term and long-term funds sit intermediate bond ETFs, holding bonds that mature in roughly three to ten years. Their durations are typically around five to seven years, so they move more than short-term funds but much less than long-term ones.

Broad US bond market ETFs, such as BND and AGG, sit in this intermediate range. They hold Treasury, corporate and mortgage-backed bonds of many maturities, which gives them an average duration of around six years. For many investors, a single broad bond fund like this is the core bond holding in a portfolio.

Intermediate Treasury funds, such as IEF, which holds Treasury bonds maturing in seven to ten years, offer a purer middle option. They pay more than short-term funds in normal conditions, without the extreme swings of long-term funds.

Give Every Bond ETF a Job

A simple way to choose is to decide what job the bond fund will do in your portfolio before looking at any ticker. Bond ETFs that look alike on a fund list can do very different jobs.

A broad bond market fund such as BND or AGG is built to be the core bond holding. The two are close cousins, both very low-cost, both holding thousands of bonds with an intermediate duration, so most investors would hold one or the other rather than both.

A short-term Treasury fund such as VGSH or SHY does the job of stability, holding money that may be needed soon. A long-term Treasury fund such as TLT does a more specialised job: it is effectively a position on interest rates falling, or a shock absorber for a stock market crash, and it should be sized with that in mind.

International bond funds such as BNDX add another job, spreading bond holdings beyond the United States. BNDX holds mostly investment-grade government bonds from other countries and hedges currency movements, so it behaves much like a US core bond fund with slightly more rate sensitivity.

Treasury, Corporate and Other Types

Maturity is only one dimension of a bond ETF. The other is credit quality: who issued the bonds and how likely they are to pay.

Treasury bond ETFs hold US government debt, which carries the lowest credit risk. FRC’s dictionary entry on the Treasury bond explains how these securities work. Their prices move almost entirely with interest rates, which makes them the clearest example of the short-term vs long-term trade-off.

Corporate bond ETFs hold debt issued by companies. They pay more than Treasury funds, but their prices also react to the health of the economy and the companies’ ability to pay. A long-term corporate bond fund carries both high interest rate risk and credit risk.

High-yield bond ETFs hold bonds from companies with lower credit ratings. They tend to have shorter maturities, but they often behave more like stocks in a downturn. FRC’s guide to investment-grade vs high-yield bonds explains the difference.

Some bonds can also be repaid early. Callable bonds and mortgage-backed securities are often repaid when rates fall, which limits how much they gain. FRC’s guide to callable vs non-callable bonds explains how that affects bond prices.

Your hard-earned money represents years of work. Give it the respect it deserves. Advanced ETF Investing goes deeper into duration, credit risk and building a fixed-income portfolio that can handle any rate environment.

Matching the Fund to When You Need the Money

The most practical rule for choosing between short-term and long-term bond ETFs is to match the fund’s duration to your time horizon. A common guideline is not to hold a bond fund whose duration is longer than the time until you will need the money.

Money for a house deposit in two years, school fees next year or a planned purchase usually belongs in a short-term or ultra-short fund. A sharp rise in rates would hardly dent it, and there is little time to recover from a loss.

Money set aside for retirement in twenty years can carry more duration. Over that time, the higher income from intermediate or long-term funds has years to make up for any price falls, and long-term Treasuries can cushion the portfolio when stocks fall.

Emergency savings are different again. Money you might need at any moment is usually better in a savings account, money market fund or ultra-short bond fund, where the price barely moves at all.

When You Need the Money on an Exact Date

A short-term bond ETF is a good home for money needed in the next few years, but it cannot promise an exact amount on an exact day. Because the fund never matures, its value on the day you sell depends on where rates are at that moment.

If you need a precise sum on a precise date, such as a tax bill or a house completion, other tools can match that more closely. An individual Treasury bond or certificate of deposit held to maturity pays back its face value on a known date, barring default.

Target-maturity ETFs offer a middle ground. They hold bonds that all mature in a particular year, then close and return the proceeds. As that year approaches, their duration shrinks towards zero, so they behave more and more like an individual bond while keeping the diversification of a fund.

Using Short-Term and Long-Term Funds Together

Many investors do not choose one or the other. They combine them in ways that suit their goals.

A barbell strategy holds short-term and long-term funds but little in between. The short-term side provides stability and cash when needed, while the long-term side provides higher income and protection if rates fall in a downturn.

A bond ladder spreads money across several maturities. With ETFs, this can be done using target-maturity funds maturing in different years, which gives a predictable schedule of money coming back. As each rung matures, the money can be spent or reinvested at the longest end of the ladder.

The simplest approach is a single broad bond market fund, which already holds a mix of short, intermediate and long-term bonds. FRC’s guide to the three-fund portfolio shows how one bond fund fits alongside stock funds.

Costs, Tax and Trading

Both short-term and long-term Treasury ETFs are among the cheapest funds available, with expense ratios often well below 0.1% a year. Broad bond market funds are similarly low-cost. Corporate and high-yield bond funds usually cost a little more.

Bond ETF income is generally taxed as ordinary income, not at the lower rates that apply to qualified dividends. Income from Treasury bond ETFs is usually exempt from state and local income tax, which can make Treasury funds more attractive than corporate bond funds for investors in high-tax states. FRC’s guide to how ETFs are taxed in the United States explains the rules.

Because bond income is taxed as ordinary income, many investors hold bond ETFs in tax-advantaged accounts such as an IRA or 401(k) where possible. FRC’s guide on where to hold ETFs explains how account location affects your returns.

Popular Treasury ETFs trade millions of shares a day with very tight spreads. In stressed markets, though, bond ETFs can briefly trade at a discount to the value of their holdings, as many did in March 2020. FRC’s guide on what happens to your ETF during a stock market crash explains why.

Common Mistakes With Short-Term and Long-Term Bond ETFs

Treating long-term Treasuries as risk-free. US Treasury bonds carry almost no risk of default, but long-term Treasury ETFs carry a great deal of price risk. Investors who bought them as a safe place for money they needed soon learned that the hard way in 2022.

Chasing the highest yield. A long-term or high-yield fund may pay more, but that higher income is compensation for more risk. Judging a bond fund on yield alone ignores duration and credit quality.

Betting on interest rates. Buying long-term bond funds because you expect rates to fall is a forecast, not a plan. Rates have surprised professional forecasters many times, and the cost of being wrong is high.

Leaving cash needs in long-duration funds. Money you will need within a few years should not sit in a fund that could fall 15% or more if rates rise.

Selling after the fall. Selling a bond fund after rates have risen locks in the loss just as its income is starting to recover it. If the fund still matches your time horizon, holding on is often the better choice.

Investing without understanding is a risk in itself. FRC’s three progressive ETF programmes, from ETF Investing for Beginners to Advanced ETF Investing, teach you to judge a bond fund on its duration, credit quality and cost, not just its yield.

Common Questions

What is the difference between short-term and long-term bond ETFs? Short-term bond ETFs hold bonds maturing within about one to three years and barely move when rates change. Long-term bond ETFs hold bonds maturing in ten years or more, usually pay more income and can swing sharply in price when rates move.

Are short-term bond ETFs safer than long-term bond ETFs? They carry much less interest rate risk, so their prices are far more stable. They do carry more reinvestment risk, because their income falls quickly when rates are cut.

Are short-term bonds better than long-term bonds? Neither is better in every situation. Short-term bonds suit money needed soon and investors who value stability, while long-term bonds suit long time horizons and investors who want more income and protection if rates fall.

Are short-term bonds more sensitive to interest rate changes? No. Short-term bonds are much less sensitive to interest rate changes than long-term bonds, because their fixed payments are locked in for only a short time.

Why does Warren Buffett recommend short-term bonds? In his 2013 letter to Berkshire Hathaway shareholders, Warren Buffett said the instructions for his wife’s inheritance were to put 10% in short-term government bonds and 90% in a very low-cost S&P 500 index fund. He has long favoured short-term Treasuries for safety and ready cash rather than as a source of return, and Berkshire has held very large amounts of Treasury bills.

Do long-term bond ETFs pay more than short-term bond ETFs? Usually, but not always. When the yield curve is inverted, short-term funds can pay more than long-term ones, as they did for much of 2023 and 2024.

Which bond ETF is best when interest rates are rising? Short-term and floating-rate bond ETFs usually hold up best when rates rise, because their prices are least sensitive to rate changes and their income catches up quickly.

Which bond ETF is best when interest rates are falling? Long-term bond ETFs usually gain the most when rates fall, because they have locked in higher interest rates for many years.

Can you lose money in a short-term bond ETF? Yes, but losses are usually small. In 2022, one of the worst bond markets in decades, short-term Treasury funds fell only around 4%, while long-term Treasury funds fell around 30%.

Is a long-term bond ETF a good hedge against a stock market crash? Long-term Treasury funds have often risen when stocks crashed, as in 2008 and 2020. In 2022, both fell together, because rising inflation pushed rates up and hurt stocks and bonds at the same time.

How do short-term and long-term bonds behave in a recession? In a recession, interest rates usually fall as the Federal Reserve cuts rates and investors seek safety. Long-term Treasury funds tend to gain the most, short-term Treasury funds gain a little, and corporate and high-yield bond funds can fall if investors fear defaults.

Should you buy bonds when interest rates are high? Higher rates mean bond funds pay more income, and if rates later fall, their prices can rise too. Nobody can reliably predict rates, so many investors choose a bond fund whose duration matches when they will need the money rather than trying to time the market.

Do short-term bond ETFs mature? No. Most short-term bond ETFs keep selling bonds as they approach maturity and buying new ones, so the fund itself never matures. Target-maturity ETFs are the exception, because they close in a set year and return the proceeds.

Should I hold short-term or intermediate bond ETFs? It depends on your time horizon. Intermediate funds, including broad bond market ETFs, usually pay more than short-term funds and suit money you will not need for five years or more.

How do I know if a bond ETF is short-term or long-term? Check the fund’s fact sheet for its average maturity and effective duration. A duration of around two years or less signals a short-term fund, while a duration of fifteen years or more signals a long-term fund.

Your Portfolio Deserves an Educated Investor

Short-term and long-term bond ETFs can both hold safe, high-quality bonds and still behave completely differently. One steadies a portfolio, the other can swing like a stock, and the right choice depends on when you need the money and which risk you can live with.

Imagine knowing exactly what you own, why you own it and what risks you’re taking. FRC’s three progressive ETF programmes take you from how bond funds work, through matching them to your goals, to building a portfolio that can handle rising and falling rates. FRC’s programmes and memberships are open to everyone, whether you are investing $500 or $500,000.

Invest in understanding the market before investing in the market itself. Check the duration before you choose the fund.