Ultrashort Bond Funds: More Risk Than Reward? 5.00 / 5 (100.00%) 1 vote

One thing about human beings is that we love a win-win situation. Every investment carries an element of risk and we all know this. We also know that high risk investments come with high rewards if we get it right. On the other hand, reduce the risk and you are likely to reduce the profit too. Most people know this but there are investors out there who insist on a low risk and a high profit investment. This is not what the book says so people who are bent on this abnormal formula may be taking a risk. Now, take a look at this question:

Ultrashort bond funds: more risk than reward? This is a loaded question so it makes sense to break it down into simple components and do justice to each of the components.

First, we have to explain what a bond is then we move on to the bond fund. Next, we talk about the ultrashort bond fund and point out why it carries more risk than reward for the investor. A bond is a fixed security investment in the sense that you already know how much you will receive from the investment. It is usually issued by reputable corporations, federal agencies, state governments and municipalities. Since bonds are issued by governments and very solid corporations, these securities are usually very safe. Of course, your return on investment is also on the low side because you are not taking much risk.

Bond funds are like mutual funds in the sense that we are not talking about just one bond but a number of bonds taken as one bond fund. The aim of the bond fund is to diversify your bond investment, reduce risk and earn more money from the investment. Generally, bonds are long-term investments (5-30 years) but the ultra-short bond-fund is a short term investment (3 months-2 years). The aim of the ultra-short version is to give investors a deal with the security of the long-term bond, the high yield of a short-term investment and the relative liquidity of a short-term investment. Clearly, this is a tall order but this is a good example of the illusive win-win situation some investors look out for.

The main problem with the ultra-short bond fund is that safety is not guaranteed. In fact, some agencies that offer this instrument are not properly regulated so they might be guilty of sharp practices and this can lead to huge losses for the investor.  Another problem with the ultra-short bond fund is that it carries a high risk of default. People who offer this product try too hard to give the investor impossible returns and this may lead to default. The only good thing about the ultra-short bond fund is that the short duration means that the investor is not likely to lose money in case interest rates go against him or her. Unfortunately, the credit risk by far outweighs the interest rate risk in this context.

Now, we can look at this question again: ultrashort bond funds: more risk than reward? The answer is a resounding yes. Do not risk your money because the risk outweighs the benefits by far.