Today I’m going to talk a bit about an asset class I recently started using, which are Ultrashort Bond ETFs. The name makes them sound like something that invests in companies that produce extreme board shorts or something, but it’s actually far more mundane.
What are Ultrashorts?
Remember that there are two basic asset classes in an investment portfolio: Equity and Fixed Income. Equity generally invests in companies, while fixed income generally invests in bonds. I know there are more esoteric things like Preferred Shares (which we write about here), but let’s keep things simple for this example.
When picking a bond ETF, there are two basic knobs you can turn: Credit Quality and Duration. Credit quality is a measure of how likely the bond’s interest payments will be made. A high credit quality like the US government’s means the bond will definitely be paid, while a lower credit quality like some airline means the bond might default. Lower credit quality bonds will generally have a higher yield, since investors will demand to be compensated for taking on the risk.
Duration measures the average time to maturity of the bonds in that fund. The longer the duration, the more sensitive it is to interest rate changes by the central bank, and therefore the more volatile that fund will be.
Ultrashorts are designed to be ultra-safe (maybe they should have called them that instead). So they typically invest only in bonds that have the maximum possible credit quality (like government bonds), and the shortest possible durations. These ETFs only pick up bonds that are less than a year from maturing, making their durations ultra short, hence the name Ultrashort.
And for the eagle-eyed finance nerds out there who may be thinking “Wait, isn’t this the same as a money market fund?” The answer is that they’re very similar. Money market funds basically do the same thing, but they’re structured as mutual funds, meaning you can only buy them if you open up an account at that financial institution. Ultrashorts are ETFs, meaning they’re traded on the stock market and therefore can be bought by anyone with a trading account.
I’m going to use SHV, which is iShares’ largest Ultrashort fund, as an example here, though all Ultrashorts should behave the same. Right now, SHV’s 12-month trailing yield is about 2.35%, so it’s basically yielding what the short end of the US treasury yield curve is paying. If we were to pull up SHV’s price history, it looks like this:
Ultrashorts trade in this unique “saw-tooth” pattern. This is because Ultrashorts’ price is typically only affected by one thing: when the next interest payment will be.
SHV distributes interest payments at the end of each month. So as the date gets closer to the end of the month, it’s share price rises in anticipation of that sweet sweet cash distribution. Then, when that cash distribution get paid out, its share price drops by the same amount as that distribution since the fund just gave everyone a bunch of cash, then the cycle repeats itself.
The best time to buy into an Ultrashort fund is at the bottom of the saw-tooth cycle. That way, your position will only be in one of two states:
- Going up in value as the month goes on
- Bouncing back down to your original buy price when you get paid interest
Doing this allows you to exit your position at any time and still get part of that month’s interest payment. For example, if you need to get out halfway through the month, the ETF will have gone halfway up the saw-tooth, so if you sell at that point, you will get half that month’s interest as a capital gain.
So basically, an Ultrashort is a low-risk way of making money, since it invests in low-risk assets like US treasuries, while at the same time being super liquid, since you can get out at any time with all your money (and any partial interest you’ve earned to boot!)
Who Should You Own This?
Now I’m not suggesting you go dump all your money into an Ultrashort. Ain’t nobody retiring anytime soon on a 2.35% return rate. But as it turns out, these can be pretty useful to some people as part of your retirement portfolio. Specifically…
If You’re Retired and Need a Place To Store Your Yield Shield
When you’re still working, we generally advise that as you get dividends you reinvest them since you don’t need the cash right away. But when you’re early retired like us and your portfolio is structured as a Yield Shield, you need that cash you’re generating to live.
Over the course of the year, our portfolio throws off about $35,000 in cash. That’s not chump change. And by simply putting that cash as it gets generated into an Ultrashort, I can make interest on that as the year goes on. What has two thumbs and likes free money? THIS GUY.
If You Have a Lot of Foreign Cash
Despite the fact that I’m Canadian, I actually hold a lot of US cash these days. This is because most of the advertisers on this blog, plus our publisher happens to be American, so when we get paid it’s in USD. And because I’m Canadian, we have very limited places to put that USD. A typical USD-denominated savings account in Canada, for example, might pay 0.01%.
But if I stick my USD in a brokerage account and buy a USD-denominated Ultrashort fund like SHV, I can actually earn a decent American interest rate on that money despite the fact that I’m not American myself.
So whether you’re holding Canadian Dollars, American Dollars, Pounds, or Euros, there’s a way to get an interest rate on that money as if you’re living in that country using an Ultrashort denominated in that currency. Here are a few you can use.
|iShares Premium Money Market ETF
|iShares Short Treasury Bond ETF
|iShares £ Ultrashort Bond UCITS ETF
|iShares € Ultrashort Bond UCITS ETF
If You’re Not Allowed to Open up a HISA (High Interest Savings Account)
If you’re American you might be looking at all these hoops and thinking “This seems like too much work. Why don’t I just open up a Savings Account with Ally or something?” And that’s true. You can get 2.2% on your cash at Ally right now, which isn’t that far off the yield on SHV.
But one of the requirements of opening up an account with an online bank is that you have to be a U.S. citizen or permanent resident. So if you’re not one of those things (like, a non-resident alien), you can use Ultrashorts to make a low-risk return on your money.
So that’s it! The exciting world of Ultrashort Bond ETFs. Thoughts? Questions? Let’s hear them below!
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