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I want to understand the rationale behind buying into a short-term Treasury ETF (or mutual fund). In particular, I want to understand how it compares to buying short-term Treasury bonds/bills directly or placing the money in a savings account. For example, I'm thinking of Vanguard's Short-Term Treasury Index ETF (VGSH) or iShares' 1-3 Year Treasury Bond ETF (SHY). Do these ETFs have different different inflation risk and/or interest rate risk profiles than Treasury bonds/bills or savings accounts?

One difference I see is that the nominal return of Treasury bonds/bills is fixed once they're purchased. For a savings account, the principal is fixed, but the interest rate can vary (incrementally). Meanwhile, the both the value and the dividends of those ETFs fluctuate.

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    The body of your question asks very specific questions which I tried to answer below. I'll just mention casually though that for many people a portfolio entirely made up of short-term treasuries is not a great long term balance in many situations. – rhaskett Mar 27 '18 at 0:46
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It's easy to compare the ETFs you mention vs savings accounts so lets start there. The first thing to notice is the differences in yield on short term treasury ETFs vs high yield savings are not huge but large enough to be noticeable over time. As you mentioned the price of those ETFs can fluctuate but they fluctuate such a tiny amount (say compared with stocks) that it can usually be ignored. The more important difference is that there can be higher costs associated with the ETFs depending on how you trade them. The ETFs will often still a better deal overall in the long run but it's good to check the costs carefully.

As for comparing savings/ETFs to buying bills/bonds directly it depends a lot on which bonds/bills you buy. Longer dated bonds will have more interest rate sensitivity than than the shorted dated bonds in the ETFs you mentioned, but short duration bill should have similar interest rate risk. Remember the return is fixed when you buy but only if you hold to maturity. You never know when you might need to sell.

The main difference with buying bonds directly is that you have to pay more attention as your bonds as their risk will change over time and they will mature and you will need to buy more. The trading costs can be also higher depending on where/how you trade. The ETFs can trade more cheaply for you because of their scale. In the end, trading yourself really just involves more work and involves more chances of messing it up. So, I can't really recommend it.

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Except in rather special circumstances, I would not expect any short term Treasuries to be as good as a diversified equity ETF. I say this mainly because of the 7% or so historical return from equities, compared to even longer term bonds of only 3.5%.[ https://www.joshuakennon.com/stocks-vs-bonds-vs-gold-returns-for-the-past-200-years/ ]

Of course, anybody who has fixed, short-term obligations which they know the cash value of and can only meet by preserving almost all of their capital will not want to risk an equity bear market. Treasuries, especially short term treasuries, such as the 1-3 year bonds you mention, and which have a known cash return, extremely low volatility and are generally assumed to be riskless, could then be ideal.

Long-term investors should expect to be better off with the higher expected compounding annual return after taking account of volatility. The Kelly criteria [ https://www.stat.berkeley.edu/~aldous/157_2016/Slides/lecture_2.pdf ] will tell you how much better off, and will even tell you the optimum proportion of your capital to invest in volatile equities, rather than safer treasuries. Except when P/Es are astronomically high so expected returns are exceptionally low, the numbers seems to me to recommend a 100% investment in equities.

The same formula, and recommendation even applies in the short term, provided the type of obligations above do not apply and the investor has a utility function which is logarithmic. [ https://www.economicshelp.org/blog/glossary/expected-utility-theory/ ]

Given the suitability of equities for both of the above, the main groups for whom Treasuries are suitable would seem to be banks, pensions funds, and other people looking after other people's money, and for which it would be unforgivable to loose money.

Since financial advisers, also come into this category, I should say that I am not such an adviser, the above is not advice, and equities can loose money. In fact, it this risk and the fact that it cannot be diversified away that gives the expectation of reward. I should also declare an interest in the above as someone who is fully invested in equities.

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    Welcome to Money.SE. You state a number of facts, with references, but failed to really answer the question as asked. Do you mind reading the question again, and see if you can focus on what OP seems to be asking? – JTP - Apologise to Monica Feb 24 '18 at 22:07
  • Looking only at the investments mentioned by the questioner, the VGSH or the savings account would seem to be better than the SHY. This is because of the higher (0.15%) management charges. Over 10 years this is (slightly over) 1.5%, and if investing a significant proportion of one's wealth is in my view well worth avoiding. Of course, if the questioner expects to only invest short-term, or is only investing a small proportion of the wealth, then the above does not apply, and I would go for the convenience of using whatever accounts I had open and available, rather than opening something new – Value at Risk Feb 25 '18 at 9:54
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    This is what I read - "I want to understand how it compares to buying short-term Treasury bonds/bills directly or placing the money in a savings account." We may have an answer already posted on this, I need to search a bit, but it seemed OP was asking about the difference between buying a single T-note vs an ETF of similar duration. (And no, I'm not the down voter, that's not how I welcome a new member) – JTP - Apologise to Monica Feb 25 '18 at 13:14
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    Comparing specifically buying a 1-3 year ETF such as the SHY or directly buying a single Treasury of 2 years duration, the price of the two should initially track. However as the Treasury neared maturity its price should stabilize at the maturity value. The ETF however would continue to suffer volatility and interest rate risk, since it is continually re-balanced to maintain their maturity breakdown. – Value at Risk Feb 25 '18 at 23:45

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