Vanguard's Cheapest Short-Term Bond ETF Costs Just $3 a Year on $10,000. Hardly Anyone Mentions It.

Investors often choose cash management vehicles by defaulting to the first money market fund shown on a brokerage platform, which can be less than ideal when those funds are older legacy products with relatively high expense ratios. Because money market yields are already near risk-free rates, even a few extra basis points in fees can reduce returns over time, before considering taxes. Short-term bond ETFs can provide performance similar to money market funds while offering greater liquidity and lower fees. Although ETF NAV is not fixed at $1, principal loss risk for many short-term bond ETFs can remain low enough for many investors. Different ETF choices vary: 100% Treasury exposure can improve tax treatment and credit quality but may yield less, while corporate bond exposure can increase yield at the cost of credit risk and tax inefficiency, including in accounts like Roth IRAs.

"One of the things that really grinds my gears is when investors looking for a cash management vehicle simply default to whatever money market fund their brokerage platform happens to highlight first.That can be less than ideal because a lot of these are older legacy products that still charge fairly high expense ratios. And when your fund is only earning something around the risk-free rate to begin with, even a few extra basis points in fees can materially reduce your yield over time. That is before we even start talking about taxes."

"The good news is that you can get performance fairly similar to a money market fund, but with greater liquidity and lower fees, through ETFs. While the net asset value (NAV) per share is not fixed at $1 the way a money market mutual fund is, the actual risk of principal loss for many short-term bond ETFs still remains low enough to satisfy a lot of investors' risk tolerances."

"If you opt for a 100% Treasury solution, you generally benefit from exemption from state and local taxes along with higher credit quality, but your yields are usually lower. If you are willing to take on a modest amount of credit risk and tax inefficiency in exchange for higher yield, especially inside a tax-sheltered account like a Roth IRA, one option that may deserve a closer look is the Vanguard Short-Term Corporate Bond ETF (NASDAQ: VCSH)."

"For those unfamiliar, VCSH is a passive ETF that tracks the Bloomberg U.S. 1-5 Year Corporate Bond Index. This benchmark currently consists of 2,965 bonds with an average duration of 2.7 years. Duration is a measure of interest rate sensitivity. A duration this short means rising rates generally will not hurt VCSH's net asset value very much, but falling rates will not provide much upside either. That makes it more suitable for investors who are not comfortable taking substantial duration risk."

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