Short Term Government Bond Funds: Yields, Risks, and Tax Treatment

Short-term government bond funds are mutual funds or ETFs that hold U.S. Treasury securities maturing in roughly a few months to three years. They sit between money market funds and the broader bond market: they earn more income than cash in most environments, and their share prices move only modestly when interest rates change. That combination has made them a common choice for money an investor wants safe but not idle.

What’s Inside the Portfolio

The core holdings are Treasury bills, which mature in weeks, and Treasury notes maturing in two to three years. Some funds also hold bonds issued by federal agencies. Because Treasuries are backed by the taxing authority of the U.S. government, credit risk is minimal, and the SEC has described it as “less of a factor” for funds that principally invest in government securities.¹

Within the category, funds vary by how short they go. An ultra-short fund like the iShares 0-3 Month Treasury Bond ETF (SGOV) holds only T-bills maturing within 90 days, giving it an effective duration of about 0.12 years.² A more typical short-term Treasury fund like the Vanguard Short-Term Treasury ETF (VGSH) tracks Treasuries maturing in one to three years, with an average duration around 1.9 years.³ That difference matters because duration determines how much a fund’s price moves when rates shift.

How Much They Move When Rates Change

A bond fund pools investor money, buys bonds, and passes through the interest income. The share price fluctuates with prevailing rates: when rates rise, existing bonds are worth less, so the fund’s price falls. Because these funds hold short-maturity bonds, those price swings stay small.⁴

Duration is the standard measure. A fund with a two-year duration would theoretically lose about 2% if rates jumped a full percentage point, versus roughly 5% for a five-year fund.⁵ The sharp rate-hiking cycle of 2022 illustrated the difference. The broad bond market, represented by the iShares Core US Aggregate Bond ETF, lost about 13% that year, while many short-term bond ETFs lost less than 5%.⁶

As bonds in the portfolio mature, the fund reinvests the proceeds at whatever rates the market is offering that day. In a rising-rate environment, the fund gradually picks up higher-yielding bonds; in a falling-rate environment, the opposite happens.

The Risks That Remain

These funds are among the lowest-risk investment options available, but they are not risk-free.

Interest rate risk. Even with short durations, prices decline when rates rise. Short-term bonds have historically lost as much as 7% during aggressive rate-hiking periods.⁴
Reinvestment risk. When rates fall, maturing bonds get replaced with lower-yielding ones and the fund’s income drops fairly quickly. This is the flip side of the short maturities that keep price risk low.⁷
Opportunity cost. Staying in very short, very safe securities can mean earning less than intermediate or longer bonds would have delivered, especially in stable or falling-rate periods.⁷
Inflation risk. If inflation outpaces the fund’s yield, purchasing power erodes.

What these funds largely avoid is credit risk. Funds that stray into corporate debt or mortgage-backed securities introduce credit risk that pure Treasury funds do not carry, and the SEC has cautioned investors to be skeptical of any fund promising higher returns at “no additional risk.”⁸ Read the prospectus to see what a specific fund actually holds; the “short-term government” label alone doesn’t guarantee a uniform portfolio.⁹

How They Compare to Cash Options

Money market funds are governed by SEC Rule 2a-7, which imposes strict quality, diversification, and maturity constraints designed to keep the share price at a stable $1.00.¹⁰ Short-term bond funds face no equivalent SEC-mandated restrictions on duration or portfolio quality.⁹ Their net asset value fluctuates daily, meaning it is possible to lose money, even if that’s uncommon for Treasury-only funds.

Certificates of deposit offer FDIC insurance up to $250,000 and a guaranteed return of principal at maturity. Short-term government bond funds carry no such guarantee.⁸ The trade-off is liquidity. Fund shares can be bought or sold on any trading day, while CDs typically lock capital up for a fixed term.

Compared with buying individual T-bills directly from Treasury, a fund offers diversification across maturities, automatic reinvestment, and the convenience of a single ticker. The cost is a small annual expense ratio and daily NAV fluctuation.

When These Funds Fit

Morningstar describes short-term bond funds as suitable for most investors except those who are young, investing for long-term goals, and highly risk-tolerant.⁴ In practice they fill a few distinct roles.

Near-term spending reserves. Retirees drawing income from a portfolio use short-term bond funds as a source of liquidity that earns more than cash and holds up well in most environments. Morningstar calls them “next-line reserves” for spending needs.⁴
Capital preservation for a known goal. Investors saving for a down payment or a tuition bill within about two years often use short-term Treasury funds to avoid the volatility of stocks or longer bonds.
Portfolio diversification. Short-term bonds tend to have a negative correlation with stocks, so adding them to an equity-heavy portfolio can improve risk-adjusted returns.⁴

For a time horizon beyond about six years, a broader intermediate-term bond fund may deliver better returns and make a separate short-term allocation unnecessary.

Tax Treatment

Interest income from short-term government bond funds is subject to federal income tax at ordinary rates. Income derived from U.S. Treasuries is generally exempt from state and local taxes, which is a meaningful advantage for investors in high-tax states. Fund companies don’t always break the Treasury-derived portion out on tax forms, so you may need to calculate it yourself to claim the exemption.¹¹

Capital gains can also arise, either inside the fund when it sells bonds at a profit or when you sell shares for more than you paid. Gains are taxed at ordinary rates if short-term and at reduced capital gains rates if long-term.¹² Holding the fund inside an IRA or 401(k) defers all of this until withdrawal.

Current Yields and Major Funds

As of mid-2026, the Federal Reserve has held its target rate at 3.50% to 3.75%.¹³ Two-year Treasury yields sit near 3.92% and five-year yields near 4.07%.¹⁴ SEC yields on most short-term Treasury funds fall between roughly 3.5% and 4.1%, depending on maturity profile. Expense ratios in this category are unusually low, as little as 0.03% a year, reflecting the simplicity and scale of indexing Treasuries.

A few of the largest options, with data as of mid-2026:

iShares 0-3 Month Treasury Bond ETF (SGOV). The largest ultra-short fund at roughly $96 billion in net assets, a 0.09% expense ratio, and a 30-day SEC yield of 3.56%. Effective duration is 0.12 years, making it the closest thing to a cash substitute in the ETF market.¹⁵
SPDR Bloomberg 1-3 Month T-Bill ETF (BIL). About $46 billion in assets, 0.14% expense ratio, 30-day SEC yield of 3.51%, and duration of 0.14 years. It returned roughly 4.16% in 2025.¹⁶
Vanguard Short-Term Treasury ETF (VGSH). About $33.8 billion in net assets, a 0.03% expense ratio, a 30-day SEC yield of 4.14%, and 91 holdings of one-to-three-year Treasuries. Morningstar rates it Gold.³⁶
iShares 1-3 Year Treasury Bond ETF (SHY). About $25.3 billion in assets, 0.15% expense ratio, 30-day SEC yield of 4.03%, and effective duration of 1.87 years. Three-year annualized return of 3.89% through March 2026.¹⁷
Schwab Short-Term U.S. Treasury ETF (SCHO). About $12.6 billion in net assets, 0.03% expense ratio, TTM yield of 3.94%, and a three-year annualized return of about 4.2%.¹⁸
SPDR Portfolio Short Term Treasury ETF (SPTS). About $6 billion in assets, 0.03% expense ratio, 30-day SEC yield of 4.08%, and duration of 1.86 years across 112 holdings.¹⁹
Vanguard Short-Term Treasury Index Fund (VSBSX). A mutual fund alternative with $3.1 billion in its Admiral Shares class, a 0.06% expense ratio, a $3,000 minimum investment, and 91 bond holdings entirely in U.S. government securities.²⁰

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