Bond ETFs vs. Money Market Funds For Short-Term Cash

Includes: IEF, SHY, TIP, TLT
by: SA Editors

A reader of Bill Cara's asks:

For short-term parked lump sum funds (say one year), why not just buy Treasury ETFs (SHY; TIP; TLT; IEF) which pay as good or better yields as CD/Money market rates, without the hype & hassle... quick liquidity is not a problem since I can sell ETFs to generate the $$$ I need, when I need, vs. tied up in a CD for 6+months at lower MM rates. TLT's (20 yr) yield is at at 4.97% current.... What difference does it make to me if it's 20 yrs if I can sell the ETF anytime?... The ETFs could fluctuate slightly in value vs. CD or MM but I don't think that’s a lot of risk.

Bill's response: market funds [MMF] are professionally managed, and typically also come with advice of a personal financial advisor... but, as I see it, a MMF is a savings tool, which is a different asset class... On the other hand, an ETF represents a securities trading instrument, which is what traders need.

I believe that index tracking ETF’s are far superior to at least 95 pct of the managed funds available to the public. For example, a Treasury ETF is in my view a superior product because, as you indicate, the costs are less and the liquidity greater. But under the control of a bad trader, any ETF can produce inferior results.

By holding an ETF, what you are in effect saying is that you believe that net-net you can produce portfolio results that are superior to professional traders who actively manage the comparable mutual fund products. For many people that’s a stretch. But since about 80 pct of professionally managed funds under-perform the broad market indexes, I agree you have a good shot.

If you are successful at trading other ETF’s I see no reason you ought not to be using Treasury ETF’s as a replacement for your MMF's.

Two responses from the comments there:

'Maybe I'm missing something, but in one year TLT could easily lose more than 5% and is NOT worth the risk vs. a money market fund... Why don't you just ladder out T-Bills? Then you have a maturity date which ETF's don't have. Also, you can get 4% with a money market fund that has a higher minimum, with full liquidity. Trying to squeeze the extra few basis points in yield is not worth the downside risk.'

'The ETF's are a very convenient liquid way to trade the yield curve. As an alternative to individual bonds and bond funds they are preferable for my purposes... (But) they are not a money market and inappropriate as a cash alternative in my opinion.'

Here's a full, constantly updated listing of US Government Bond ETFs and Broad US Bond ETFs. Note that State Street now offers a 1-3 Month T-Bill ETF (NYSEARCA:BIL).

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