Investors looking for a relatively stable asset class capable of earning modest returns in the short term may look at exchange traded funds (ETFs) or short-term bond funds. Both are good options for short-term investing when one is concerned about rising interest rates in the near future. However, short-term returns can come back to bite the investor whose expectations about interest rates do not come to fruition.
An ETF is a marketable security similar to a mutual fund in that it is made up of a collection of stocks, commodities, or bonds. The ETF is also similar to an index tracking fund in the sense that it tracks an index or market segment as a means of determining how the fund's resources are invested.
A short-term bond fund is a specific kind of ETF that focuses only on bonds. These can be corporate or government bonds, although the former is preferred for investment purposes because they tend to generate higher yields. For the purposes of this article, we will not distinguish between short-term bond funds and ETFs.
The big difference with an ETF is that it trades like stock rather than a mutual fund. Individual stocks are traded on a moment-by-moment basis which can lead to significant price fluctuations on any given day. ETFs trade the same way. On the other hand, mutual funds are valued at the close of the business day based on the performance of all the individual stocks within those funds. This difference must be considered by any investor looking at the potential of ETFs.