Bonds are considered stable and therefore boring additions to a portfolio. However, the rise in interest rates has brought short-term bonds back into focus as a source of returns. We explain how short-term bonds work, when they are worthwhile and what investors can expect here.
The most important in a nutshell
- Short-term bonds usually have a term of up to four years
- They are generally regarded as very safe investments, but there are also risky variants (for example from some companies) that promise higher returns
- Short-term bonds are heavily dependent on current interest rate trends
- Bonds are well suited as a stable addition to a portfolio
How short-term bonds work
If a company, state, bank or other institution needs money, there are several options open to them. The cheapest option is often to issue bonds:
- Other market participants (e.g. private individuals, banks, etc.) can buy them and lend money to the issuer in this way.
- The lender receives interest, the so-called coupon, for the loan.
- At the end of the term, the bond is repaid, i.e. the buyers receive the original amount back.
- The coupon, on the other hand, is paid out regularly, usually semi-annually or annually.
- Bonds are exchange-traded financial products whose price can fluctuate. They are therefore also suitable for price speculation.
Successful repayment of bonds requires that the issuer has sufficient capital at maturity. This is known as issuer risk: if the issuing company, state, etc. goes bankrupt or has serious difficulties, the bond may not be serviced and the buyers lose the capital invested.
The higher the risk, the better the interest rate. This is because the issuer then has to promise a higher return in order to sell its bonds. For this reason, government bonds are regarded as particularly safe investments. It is extremely unlikely that an industrialized nation will go bankrupt. In return, there is usually only low interest.
However, other countries, for example from South America, can offer riskier bonds with higher interest rates. Companies also issue short-term bonds, often with high interest rates.
The risk here is considerably higher: while a state bankruptcy is a rare occurrence, companies slide into insolvency almost every day! Among the millions of short-term bonds available, you are sure to find one that fits your strategy.
What is a short-term bond?
Bonds are always issued with a fixed term, at the end of which the amount is repaid to the buyers. Short-term bonds are generally products with a term of less than four years.
However, the term is not exactly standardized and there are a few things to consider:
- Some sources only refer to bonds with a remaining term of one year as short-term bonds.
- The issuer of a short-term bond determines the term and the interest rate that buyers receive. They are therefore also referred to as fixed-interest securities.
- The interest rate reflects various factors such as risk or the current prime rate at the time of issue.
- Once issued, the interest rates of a bond can no longer be changed.
Numerous factors affect the price of a bond. With a short remaining term, there is less opportunity for such effects. Short-term products are therefore considered less risky, which is often (but not always!) reflected in lower interest rates.
All fixed-interest securities will eventually become short-term bonds: Even 30-year government bonds will eventually approach their redemption date.
What influences the price of short-term bonds?
As with all products on stock exchanges, the price is determined by supply and demand. In addition, pricing is influenced by a number of factors that are unique and can only be found in bonds:
1. Interest rate changes
The interest rates of a bond are fixed from the outset, but the current prime rate can change. Depending on how the interest rate environment develops, short-term bonds can become more or less attractive.
| Key interest rate rises | The bond is still based on the old, lower key interest rate and offers less interest. It is therefore less attractive and its price is falling. |
| Key interest rate falls | The bond is still based on the old, higher key interest rate and offers higher interest rates than a new product. It is therefore more attractive and its price rises. |
Bonds therefore always reflect the interest rate situation at the time of issue. The securities themselves remain the same, but the current interest rate situation can change. This effect depends heavily on the term: with short-term products there is simply less time and therefore less risk.
2. Publisher
The most important price factor is probably the issuer. Short-term bonds are always based on the hope/assumption that repayment will be made at the end of the term. The financial situation of the issuer is therefore of great importance.
- At Government bonds the risks are usually low, as a sovereign default is extremely unlikely in most nations. In the case of short-term government bonds, factors such as the economic situation of the country play more of a role: the economy influences the price of fixed-interest securities.
- Another important category is the so-called Savings bondsMedium to short-term bonds issued by banks. They offer a manageable return, but are also considered very safe as they are covered by deposit protection up to 100,000 euros.
- Corporate bonds In contrast, companies react much more strongly to business figures, market changes and similar influencing factors. Insolvency is much more likely than a state bankruptcy. Due to the higher risk, most companies also have to offer significantly higher interest rates.
- Mortgage bonds use real estate as collateral that could be sold in the event of insolvency. In terms of security, they usually lie between corporate and government bonds. Susceptibility to price changes, but also interest rates, are primarily in the mid-range here.
3. Supply and demand
Ultimately, short-term bonds are stock market products whose price is determined by supply and demand. If the economic climate deteriorates, demand for safe government bonds often increases and the price rises. Conversely, market confidence can reduce interest and consequently the price.
The interest rate on short-term bonds is rather low, depending on the issuer. Government bonds often cannot even outperform the average inflation rate. The influence of interest rate changes and similar factors is therefore often negligible. Instead, it is primarily the mood of market participants that is decisive for pricing.
Short-term bonds compared with longer maturities
Of course, it is not just short-term bonds that are available: medium and long-term variants offer equally useful investments and each come with their own advantages and disadvantages.
- A longer term means more opportunities for interest rate changes, fluctuating economic situations, crises and the like.
- This increases the risk associated with long-term bonds.
- Short-term bonds come with a lower risk due to their manageable term.
- As a result, their interest rates are generally lower, which has reduced the importance of short-term bonds.
If you want to buy a short-term bond with a term of three years, for example, you "only" have to make a forecast for the next three years. If, on the other hand, we buy such a security with a remaining term of ten years, we have to plan just as far ahead. a much more difficult undertaking!
Over such a long period, the probability of rising interest rates (and thus falling bond prices) increases dramatically.
The relationship between long-term, medium-term and short-term bonds is not always so clearly staggered. For example, in the turbulent phase between the COVID crisis and the start of the Ukraine war, i.e. between 2020 and 2022, interest rates shifted: suddenly almost all maturities had the same interest rate!
Special case: holding the bond to maturity
Considerations regarding the price of a short-term bond become obsolete at the end of its term. Once a bond has expired, buyers receive their invested capital back - provided the issuer of the bond has not run into payment difficulties.
- For this reason, the current price of a short-term bond returns to the initial value at the end of the term.
- Traders on the stock exchanges know that the bond will soon repay the original nominal value.
- Fewer and fewer people are prepared to pay different prices for these very short-dated bonds shortly before maturity.
- Interest (coupon) was already paid during the term.
If you plan from the outset to hold a bond until the end of its term, you don't have to worry so much about short-term price fluctuations. The price will level out again by the end of the term at the latest.
However, there are two possible disadvantages that you may face in such cases:
- The coupon is calculated as a percentage of the bond price. If the price falls on the stock exchange, you will also receive less interest.
- By holding them for longer, you may miss out on better investments. These include not only alternative forms of investment, but also other bonds from the same issuer.
Influence and significance of rating agencies
As you are dependent on repayment by the issuer in the case of bonds, this results in a Issuer riskThe company, bank or state could become insolvent in the meantime.
Rating agencies are available to better assess this risk, which rate long-term, medium-term and short-term bonds. The rating code is structured as follows:
| Evaluation | Fitch | Description |
| Investment grade | AAA | Minimal credit risk |
| AA+AAAA- | Very low credit risk | |
| A+AA- | Low credit risk | |
| BBB+BBBBBB- | Moderate credit risk | |
| Below investment grade | BB+BBBB- | Significant credit risk |
| B+BB- | High credit risk | |
| CCC+CCCCCC- | Very high credit risk | |
| CCC | In or about to default, with the chance of recovering only part of the loan amount | |
| DDDDDD | In or about to default, with a small chance of recovering only part of the loan amount |
There are minor differences depending on the rating agency. The best-known companies, Fitch and S&P, rate very similarly, while "Moody's" uses a simple numbering system instead of plus and minus.
Important!
All agencies can only indicate current conditions and cannot make forecasts. They are also dependent on the information they receive from the issuers of the bonds. This is not usually a problem with government bonds, but some companies have a dubious information policy.
Looking at the current interest rate can also be a good way of assessing the issuer risk: very high interest rates for a (new) bond indicate higher risk and problems. Interest rates as an indicator often react more quickly to current events than rating agencies.
When are short-term bonds worthwhile?
Short-term bonds face strong competition from other financial products, which often offer significantly higher interest rates or the prospect of strong price gains. Nevertheless, fixed-interest securities make sense in many scenarios:
- Due to the high level of security promised by government bonds, they remain extremely important for investors looking for low-risk investments.
- It is also often overlooked that short-term bonds are quite liquid. They can be sold in a relatively short time. Just because a security has a term of 10 years or more doesn't mean you have to hold it for that long!
- Thanks to modern offerings such as bond ETFs, short-term bonds are another interesting opportunity to invest money in a way that is both accessible and profitable.
Bond ETFs generally exhibit only minimal price fluctuations. If you need to access your capital in an emergency, you will therefore rarely suffer a price loss. Short-term bonds can therefore be a sensible home for your "nest egg"!
ETFs made up of short-term bonds also have other advantages: as they contain a pool of different bonds, there is less risk of clumping.
The ETF also takes care of "updating", i.e. exchanging bonds that are no longer lucrative or expiring, for you. In return, you have to pay an annual fee. However, this is usually less than 0.5 percent.
For whom are short-term bonds unsuitable?
Although they are generally attractive investments, short-term bonds are not suitable for everyone:
- Anyone looking for high yields will quickly be disappointed, especially with safe government bonds. Here, corporate bonds with higher interest rates could be a better alternative.
- If you are looking for an investment with immediate liquidity, short-term bonds could also cause problems: Although they can be paid out comparatively quickly, they can come with high costs. A traditional call money account is often the better choice here.
- Do you want to avoid price fluctuations completely? Short-dated bonds are less prone to price changes than equities, for example, but changes can still occur.
- For investors looking for a high, regular return, there may be better alternatives to short-term bonds. For example, you could Trade options and achieve an attractive annual return with income strategies.
Choosing the right broker
Short-term bonds are highly dependent on the broker you use! This is because many providers actively advertise a large selection of securities, but perform poorly when it comes to short-term bonds:
- There are millions of corporate, government and other securities! Many brokers do not venture into this area and only offer a few standard bonds (US or German government bonds).
- This can lead to major disadvantages for you if you are interested in short-term bonds: The small selection keeps you from making good use of the worthwhile securities!
- Local restrictions can also lead to increased costs if you purchase short-term bonds. The perfect broker should therefore offer worldwide trading.
- In addition, many brokers charge absurd commissions for buying and selling short-term bonds: you may well have to cede one percent or more for the trade, which equates to a large part of your interest!
Therefore, when choosing a broker for short-term bonds, pay attention to the selection and fee model. In case of doubt, it may be worthwhile choosing a broker for short-term bonds. Open a CapTrader custody accountto benefit from the enormous selection and favorable conditions.
Advantages and disadvantages of short-term bonds
Short-term bonds have specific advantages and disadvantages that distinguish them from longer-term products and other investment options. These include:
Advantages
- Short-term bonds offer a very similar interest rate level to medium-term and long-term bonds.
- At the same time, the price of a short-term bond is exposed to significantly less risk. In contrast to long-term products, there is less time in which an interest rate change by the ECB could have a negative impact on the price.
- Short-term corporate bonds offer a solid return that can easily compete with other fixed-interest products. For example, the numerous offers include short-term bonds that outperform an overnight or fixed-term deposit account.
- You can also purchase short-term bonds via ETFs, which means you don't have to search for the best products manually. This gives short-term bonds an additional advantage over other fixed-interest products, which you also have to check and adjust regularly.
- "Short-term bonds" are a category with hundreds of interesting securities, each with their own risks and opportunities. Almost every investor is likely to find a product that is suitable as an addition to their own portfolio.
- The classic government bond of an industrialized nation is still one of the safest exchange-traded financial instruments. Whether as a long-term, medium-term or short-term bond, it offers the opportunity to bring additional stability to your own portfolio
Disadvantages
- Despite their short maturity, short-term bonds are not immune to price changes: if interest rates rise, the price of a bond falls - regardless of its maturity! In such cases, the only option is often to hold the short-term bond until it reaches maturity and the price returns to its original value. Otherwise, the security can only be sold at a loss.
- Short-term bonds are generally subject to the same issuer risk as medium- or long-term variants. The probability of the issuer defaulting can differ massively! While the risk of a government default is minimal with German government bonds, for example, the risk can be very high with some (seemingly) lucrative corporate bonds.
- Many brokers charge high fees and minimum amounts for trading bonds. You should therefore make sure you choose a suitable broker for these securities. open a securities account!
Conclusion: Short-term bonds for security and liquidity
Buying bonds means lending money to the issuer and receiving interest in return. Repayment is made at the end of the term - provided the government, company or bank behind the bond has not become insolvent. Short-term or short-dated bonds are those where the redemption date is a maximum of four years away.
Due to the stability of most issuers, government bonds are considered very safe financial products with rather low interest rates. However, riskier variants with higher yields, issued by companies for example, are also available.
Long, medium and short-term bonds are traded on stock exchanges and can have fluctuating prices. For example, they react very strongly to changes in the key interest rate or the economic situation of the issuer. This also makes them suitable for price speculation.
Contrary to their reputation, they don't have to be boring investments: Bonds are surprisingly liquid, flexible assets that can even be traded through special bond ETFs!
Although their returns cannot usually be compared with Blue chip shares or successful Growth shares as a stable addition to a well-diversified portfolio; as a stable Equity portfolio short-term bonds should not be missing.
