If you have a near-term goal you want to save for, you’ll want to earn the best possible return while taking the lowest amount of risk. Short-term investments can help you achieve this. Ideally, the best short-term investments should provide a safe and easily accessible place to park your money for your goals, while also earning some interest.

What are short-term investments?

A short-term investment is one that can be easily converted to cash, such as a high-yield savings account, a money market account, or certain bonds.

If you’re investing in the stock market, it’s generally considered a good idea to plan to keep your money invested for at least five years — that allows you time to ride out market volatility. But a savings goal of five years or less doesn’t mean you need to let your cash sit idle. There are several ways to help your money grow, even within a limited timeframe.

Short-term investments offer different interest rates and investment returns than long-term investments. For the most part, growing money for a short time through interest-bearing accounts is extremely low risk. You go into the agreement knowing how much interest you’ll earn over a preset period of time.

Best short-term investment options

1. High-yield savings account

High-yield savings accounts (HYSAs) allow you to deposit money into an interest-bearing bank account that typically offers higher-than-average annual percentage yields (APYs) compared with a typical savings account. The higher your balance is, the more interest you can collect on your funds over time, making this an ideal place to hold money you intend to use for an emergency fund or a short-term goal. Bank savings accounts are also FDIC-insured, meaning that up to $250,000 of your money per institution, per depositor, is protected in case of a bank failure.

NerdWallet’s analysis shows that the annual percentage yields for high-yield online savings accounts are currently above 4%. This may not sound like much, but it’s higher than 0.38%, the current national average interest rate on savings accounts and what you’ll likely be offered at your hometown bank branch [0] View all sources Federal Deposit Insurance Corporation . National Rates and Rate Caps . Accessed May 16, 2024.

Potential interest rate: 4%+.

Where to open one: Any physical or online bank that offers a HYSA. The bank that works best for you depends on the type of interest rate you’re looking for, as well as other factors such as convenience, deposit and withdrawal times, bonuses, and whether you want to open additional accounts within that bank’s ecosystem.

Nerdy Perspective I had long held the misconception that there must be a “catch” to earning interest through a high-yield savings account. I assumed they must charge fees, require a steep minimum deposit, and have strict rules around withdrawals. Because of this, it didn’t seem like the right place to keep my emergency fund. Now, I wish I had done my research sooner. In reality, there are many high-yield savings accounts that don’t have these drawbacks. Don’t let your assumptions scare you away from earning interest on your savings. Bella Avila Content Management Specialist

2. Cash management account

Another alternative for short-term savings is a cash management account (CMA). These accounts tend to offer services you’d expect from traditional savings and checking accounts — such as check writing, mobile check deposit, bill pay, money transfers, goal-setting and overdraft programs — but are offered by online brokerage firms and robo-advisors instead of banks. The benefit here is that as an investor, you can keep all your funds under one roof. You may also get higher interest rates on that parked cash than you might find by placing your money in a traditional savings account.

To provide insurance, cash management accounts often sweep funds into partner banks, where the funds will then be covered by that bank’s FDIC insurance. In some cases, the CMA will partner with a number of different banks, which can raise your overall FDIC insurance limit since part of the limit is per institution.

Potential interest rate: 3%+.

Where to open one: Any brokerage or robo-advisor that offers cash management. You’ll want to consider interest rates, any additional fees you might incur and whether you’d like to use that provider for investing services in addition to cash management.

» Next step: View our list of the best cash management accounts

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3. Brokerage cash sweeps

Some — but not all — brokerage firms pay a high interest rate on uninvested cash. This could be money you’ve chosen not to invest, dividend payments that aren’t reinvested, profits from the sale of an investment or other cash that has accumulated in your account.

Some brokers may call this buying power — it is effectively the cash available to buy securities. But it doesn’t have to be used that way, and if you opt for a brokerage firm that pays a high interest rate, you can earn a high return on that idle money.

One thing to keep in mind: In most cases, this uninvested cash will be covered by SIPC insurance, not FDIC insurance. SIPC protects up to $500,000 (up to $250,000 of that can be cash) per person, per brokerage account in the event the brokerage firm becomes insolvent.

Potential interest rate: 4%+

Where to open one: Since cash sweeps are merely one of the offerings that many brokerage accounts have, you’ll want to make sure you open an account with a firm that meets your expectations when it comes to fees and usability as well.

» Next step: View our picks for brokers that pay high interest rates

4. Bank certificates of deposit

Certificates of deposit — also known as CDs — can be a good risk-free savings option for money you are sure you don’t need for a set period of time. They work like this: You agree to put money into a bank account for a set period of time (ranging from three months to five or more years) in order to collect a preset, guaranteed interest rate on those funds. In general, the longer the term, the higher the interest rate.

Remember that you may want to avoid locking your money up in a long-term CD when interest rates are rising. However, when rates are expected to fall, CDs can allow you to lock in a high rate. If you need to withdraw your money before the CD term ends, you’ll typically pay a penalty of three to six months’ interest. Also, note that CDs may have a minimum deposit requirement.

Potential interest rate: 3% to 4%, depending on CD term.

Where to open one: Most banks and financial institutions offer CDs. When choosing a CD offer, it can be helpful to look at rates and terms to find a good fit for your particular goal.

» Next step: View our list of the best CD rates

5. Short-term bond funds or Treasury accounts

A bond is a loan to a company or government that pays back a fixed rate of return. A bond is generally considered a safer investment than stocks, but it still carries some risks: the borrower could default, or bond values could decline when interest rates rise.

To reduce the risk of default, choose bond funds that primarily own government bonds or invest through a Treasury account, which typically invests in Treasury Bills, holds them to maturity and then reinvests the proceeds in more T-bills. Treasury accounts aren’t as common as CDs or savings accounts, but they’re becoming more readily available.

Potential interest rate: 4%+.

Where to open one: You can purchase bond funds via an online brokerage account. Registered NerdWallet users can access a Treasury account through a collaboration with Atomic. Public, an online brokerage firm that NerdWallet reviews, also offers such an account. Wealthfront, a robo-advisor, offers an automated bond ladder that similarly invests in U.S. Treasurys.

Investing can be complicated, and often, many have a way of making it seem more difficult than it is. The main goal for anyone who socks their money away is to make as much money as possible. Some of the safest avenues to save and earn interest are traditional accounts, such as a savings account or a certificate of deposit (CD).

The challenge? These traditionally “safe” savings vehicles often can’t keep pace with inflation, which means your money could be losing purchasing power over time. For example, you often face the problem of inflation when putting away money in savings accounts. Inflation means prices are rising, so your money buys less over time. So, with inflation at 2.4% for the trailing 12 months as of May 2025, a savings account paying 1% interest would be losing about 1.4% of its purchasing power.

Key Takeaways Traditional savings accounts and CDs typically offer returns below the inflation rate, which means your money could be losing purchasing power over time.

ETFs can offer higher potential returns than savings accounts by investing in baskets of stocks, bonds, or other securities, though they come with more risk.

Consider your time horizon before investing—ETFs are generally better suited for long-term goals than emergency funds or near-term expenses.

Unlike savings accounts insured by the Federal Deposit Insurance Corp. (FDIC), ETFs can lose value when markets decline, making them a riskier but potentially more rewarding option.

In addition, most people want to do more than just hold steady with the rate of inflation. That’s why many investors turn to exchange-traded funds (ETFs) as an alternative to traditional savings accounts. These funds work by pooling money from many investors to buy a big collection of investments—stocks, bonds, or other assets.

ETFs can have just bonds or just stocks or just some other asset, or a mix of different types of assets. The trick is to find ETFs that have more of the kind of stability you’re used to but with a higher rate of return than you would get from a savings account. Below, we take you through eight likely to meet this standard.

Using Exchange-Traded Funds (ETFs) To Save

ETFs have changed how many everyday people invest their money. These funds sell shares on the major exchanges that give you ownership of a part of baskets of stocks, bonds, and other investments. Americans have embraced these investment tools in a big way—as of March 2025, over 4,000 U.S.-based ETFs managed over $10 trillion in assets.

While ETFs generally carry more risk than a savings account (meaning your investment could go down in value), many ETFs are designed to be less risky than buying individual stocks. They do this by spreading your money across many different investments. That’s so that if any of them do poorly, they can potentially make that up from the others.

For people who don’t need their money right away, these investment tools might work better than traditional savings accounts or CDs for building long-term wealth. Below, we’ll look at four main types:

Index ETFs that track the broad market moves. In other words, when you hear the market is up today, that would mean your ETF should be up, though you’ll want to listen or read for which index is up since your ETF might be linked to one of them. Bond ETFs that focus on more stable investments Sector ETFs that target specific parts of the economy. Money market ETFs that hold short-term government bonds, akin to bank money market funds.

Many easier-to-understand ETFs within this group have often outperformed inflation. To get higher returns, you’ll need to take on more risk, but many ETFs offer much lower risk than individual stocks.

ETFs vs. Savings Accounts

Before you dump your entire savings account into an ETF, let’s make sure you understand the differences between the two:

What Your Money Buys

Savings account : Your money stays as cash, just like keeping it in your checking account but earning some interest. The interest might be at a fixed rate or one that changes over time.

: Your money stays as cash, just like keeping it in your checking account but earning some interest. The interest might be at a fixed rate or one that changes over time. ETFs: Your money buys pieces of investments like stocks or bonds that can grow (or shrink) in value.

How Safe Your Money Is

Savings account : Up to $250,000 is protected by the government (Federal Deposit Insurance Corp.)—you can’t lose your original deposit if it’s under that.

: Up to $250,000 is protected by the government (Federal Deposit Insurance Corp.)—you can’t lose your original deposit if it’s under that. ETFs: Come with no government insurance, so their value goes up or down based on market performance.

Getting Your Money When You Need It

Savings account : Usually available anytime, though some banks limit monthly withdrawals on certain types of savings accounts.

: Usually available anytime, though some banks limit monthly withdrawals on certain types of savings accounts. ETFs: Can be sold when the major stock exchanges are open, but you might have to sell for less than you paid if the markets are down.

Important You can lose money when investing in an ETF. If you’re looking to make a major purchase soon or might other need the money soon, you might reconsider the idea of putting money into an ETF for now. That said, many ETFs are easily tradable to get your money in and out of your brokerage account relatively fast.

What You Can Earn

Savings account : Generally a fixed interest rate that’s predictable, but typically lower than ETF returns.

: Generally a fixed interest rate that’s predictable, but typically lower than ETF returns. ETFs: Potential for higher returns through investment gains and dividends, but no guarantees.

Tax Considerations

Savings account : The interest earned is taxable each year.

: The interest earned is taxable each year. ETFs: Tax implications vary. You may owe taxes on any dividends received and gains when you sell (if you sell the ETF shares for more than you originally paid). In addition, some retirement accounts can delay when you have to pay taxes until you withdraw from them later in life.

ETFs vs. Savings Accounts ETF Holds stocks, bonds, commodities, or other securities

Fluctuates in value based on the performance of underlying assets

Potential to earn a greater return

You could lose money

Trade on exchanges throughout the day

Gains are typically taxable except in some retirement accounts Savings Account Holds your money

Pays a disclosed interest rate on your deposit

Fixed or variable return that often lags inflation

Money is safe and insured if something should happen to the bank

Withdrawal restrictions can apply

Interest earned must be reported to the IRS and is taxed

Index ETFs

Index ETFs follow a large market index. Despite there being bond indexes, in general, these refer to ETFs that track a stock index. But what is that? A stock index—the S&P 500 and Dow Jones Industrial Average are two famous examples—is like a scorecard that tracks how a group of stocks or bonds is doing overall.

That is, it follows the performance of a bunch of companies’ stock prices—for example, the S&P 500, tracks 500 very large U.S. companies. Instead of looking at just one company, an index gives you a snapshot of how the whole group is doing. Indexes thus serve as benchmarks for investment performance and are the backbone of index ETFs.

These funds are also called “passive”—that’s because the managers don’t have to pick any stocks; they are already chosen to be in the index the fund is promising to follow.

The Benefits of Index Funds

Today, index ETFs cover almost every type of index imaginable, from broad market indexes like the Dow to specialized ones that focus on sectors and regions. By following an index, these ETFs offer instant diversification—this means spreading your money across different investments to cut your risk.

These ETFs are also generally lower in cost. They’re also great for knowing exactly what you’re getting—there’s no guessing what’s in them and how they’re doing since they are based on widely covered indexes that you can look up at any time. Indeed for those like the S&P 500 or Dow Jones Industrial Average, you’ll hear or read about them at the top of the news.

That said, some ETFs are not really for beginners or those needing to ensure as best as they can that they don’t lose anything in what they sock away. These include crypto ETFs, commodity ETFs, and inverse ETFs that bet against the market or specific economic sectors.

Tip The funds suggested in this article shouldn’t be seen as some beginner-type thing where you don’t see the profits like those with more money or experience do. In fact, many wealthier investors got much of their money and also learned from experience that these are some of the best ways to invest your money in over the long term.

With all this in mind, below are three ETFs to consider:

SPDRs were the first index ETFs launched in 1993 to track the S&P 500. They opened the door for investors to access an entire index in a single, tradable fund. The first was the SPDR S&P 500 ETF Trust (SPY), which mirrors the performance of the S&P 500.

Not only is it the largest ETF in the world, but it’s also the oldest. Launched in 1993, the fund has over 600 billion in assets under management (AUM). The fund’s fees are only 0.0945%, which is higher than some of the funds that track the S&P 500 but, given its size, it might save you in terms of the spreads between the bid and ask prices for shares.

Tip An expense ratio is for the fund’s management fee. For instance, for every $1,000 you invest, SPY charges less than $1.00 yearly, while another fund might charge only 40 cents. But SPY can save you money when trading because it’s very popular and trades more easily.

This is worth explaining since many investors just immediately choose funds with the lowest expense ratio. Let’s make this concrete with an example. Suppose you invest $10,000 in SPY. SPY’s 0.0945% expense ratio would cost $9.45 annually, while a smaller fund that tracks the same index might charge 0.04%, which would cost $4 a year—a $5.45 difference.

However, SPY’s higher trading volume typically results in spreads as tight as $0.01 to $0.02 per share, while less liquid ETFs might have spreads of $0.05 to $0.10 or wider. For more active traders, that can make a big difference over time. For passive investors and savers, it may depend on the specific ETF being compared to SPY.

The fund’s major holdings are listed below.

If you want to profit from the performance of smaller companies, you can try the iShares Russell 2000 Value Index ETF. Established in 2000, the fund costs less than the industry average while allowing you to have a stake in the potential giants of tomorrow.

Because its holdings are very spread out and many of them are smaller, lesser-known companies (see the chart below), it’s important to note that the top three sector weightings in June 2025 were financial firms (19.36%), industrials (18.17%), and real estate (16.08%).

If you want the broadest representation of the U.S. stock market, the Vanguard Total Stock Market ETF is popular for doing so. VTI takes the “buy everything” approach. With over 3,500 companies in its portfolio, it’s like buying a tiny piece of almost every public company in America.

VTI charges just three cents per $100 invested, making it one of the cheapest ways to own the entire U.S. stock market. Its returns, in line with the U.S. stock market as a whole in recent years, have been quite strong. The top sectors represented are technology (34.50%), consumer discretionary (14.90%), and industrials (13.10%) as of June 2025. The company holdings are below:

Fast Fact Investors often use index ETFs as core holdings along with a mixture of bond ETFs in their portfolios.

Bond ETFs

Bond ETFs allow you to invest with less stress given the safety of bonds and without the risks of holding individual bonds—or indeed higher-risk stocks and other securities. Bonds are like loans to companies or governments, and they pay you interest in return, just as you pay interest on what you borrow to credit card or mortgage companies. These funds invest in hundreds or thousands of bonds simultaneously, making your money relatively safe.

The older you are, the more your investment dollars should be in bonds. Here are two bond ETFs to consider.

Tip Unlike savings accounts, bond ETFs can lose value when interest rates rise or if companies struggle to repay their debts. However, they typically offer more stability than stock ETFs and often provide monthly income payments to investors.

The iShares iBoxx $ High Yield Corporate Bond ETF tracks the Markit iBoxx USD Liquid High Yield Index, which focuses on corporate bonds with higher interest rates but lower credit ratings. With investments in more than 1,200 of these bonds, it’s like owning a slice of corporate America’s debt market. Its returns have historically shown it can offer a higher yield than a typical savings account, though with more risk.

The bonds HYG holds are widely spread out among companies, though it has more sizable holdings in the consumer cyclical (17.69%), communications (16.70%), and consumer noncyclical (12.62%) sectors as of June 2025.

For those seeking a more conservative approach, the iShares iBoxx $ Investment Grade Corporate Bond ETF follows the Markit iBoxx USD Liquid Investment Grade Index.

This fund focuses on bonds from companies with stronger credit ratings, like Bank of America (BAC) and JPMorgan Chase (JPM). With over 2,900 different bonds and over $28 billion under management, it charges 14 cents per $100 invested.

The banking sector is the most represented in the ETF with 23.61%, with another 17.64% in consumer noncyclical, and 11.56% in technology as of June 2025.

Important ETFs make investing simpler by letting you own a whole group of stocks or bonds in one purchase, saving you the time and effort it would take to research and buy each one individually.

Sector ETFs

While broad market ETFs buy the whole market and bond ETFs focus on loans, sector ETFs zero in on specific parts of the economy. They’re riskier than broader market funds since your money isn’t spread across different industries, but they can be useful for investors who have good reason to think that particular sectors are going to do well.

Since you expose your portfolio to higher risk with sector ETFs, you should use them sparingly, but investing 5% to 10% of your total portfolio assets may be appropriate. If you want to be highly conservative, don’t use them at all.

Consider the two funds below.

The Financial Select Sector SPDR tracks the Financial Select Sector Index, which tracks the stocks of the American financial industry. For eight cents per $100 invested, you get exposure to banking giants, insurance companies, and payment processors.

As one would expect, the fund’s holdings are in various sectors of the financial world. Financial services represent 30.93% of the fund, banks make up 25.72% of the fund, 24.21% of the fund is in capital markets, insurance represents 14.58% of fund assets, and consumer finance comes in at 4.56% of the ETF as of June 2025. Major holdings include familiar names like Berkshire Hathaway (BRK.A, 12.21% of holdings), JPMorgan Chase (11.01%), and Visa (V, 8.13%).

If you were invested in the ETF in recent years, you would have your shares soar on the back of a booming financial industry. For example, as of June 2025, the fund had gained 126.95% over the past five years.

The Invesco QQQ Trust, while not technically a sector fund, has become the go-to ETF for technology investors. It tracks the Nasdaq-100 Index, which includes the largest nonfinancial companies listed on the Nasdaq stock exchange.

With tech giants like NVIDIA (NVDA, 9.08%), Microsoft (MSFT, 8.87%), and Apple (AAPL, 7.20%) among its top holdings, as of June 2025, this ETF has delivered impressive returns—129.54% over the past five years and 410.12% over the past 10 years.

Its top holdings as of June 2025 are 57.23% in technology, 19.66% in the consumer discretionary sector, and 5.80% in healthcare.

Money Market ETF

In 2024, a new kind of ETF was launched, the first true money market ETF, potentially offering the best of both worlds between savings accounts and fund investments.

The Texas Capital Government Money Market ETF marks the first time investors can access a money-market fund in the form of an ETF. For investors worried about moving beyond savings accounts, MMKT might offer an appealing middle ground. Like a savings account, it focuses on maintaining stability but also seeks higher yields than typical bank accounts.

Of particular importance is that MMKT goes beyond other ETFs following what’s known as Rule 2a-7, which is the same strict government regulation that traditional money market funds must follow. This means 99.5% of its assets must be in cash or various types of government securities.

Warning Be mindful that if you invest in an ETF within a retirement account, you might be unable to withdraw funds until retirement without paying a penalty.

While the fund isn’t FDIC-insured like your savings account, these requirements make it a more conservative approach within the range of options in your brokerage account.

The fund charges 20 cents per $100 invested (0.20% expense ratio), which is higher than some savings accounts but lower than many investment options. For investors looking to dip their toes beyond savings accounts, MMKT represents a way to acclimate yourself to how the markets and brokerage accounts work after perhaps only having bank accounts previously. Later on, if you wish, you can broaden your horizons to other ETFs like those discussed above.

Can I Lose Money by Investing in ETFs, Unlike Most Savings Accounts? Yes, it’s possible to lose money when investing in ETFs. If the underlying assets (the stocks or bonds) in the ETF portfolio decrease in value, the ETF’s share price will also decline, resulting in a loss for you. Savings accounts are generally considered safe, as they are insured by government agencies (e.g., FDIC in the U.S.) up to a specific limit, protecting against the loss of the principal amount.

Are ETFs a Suitable Option for Short-Term Savings? ETFs are generally better suited for long-term investments. Their value can fluctuate because of market movements, and they are exposed to market volatility—the ups and downs of the market. For short-term savings goals or emergency funds, savings accounts are a safer option because of their stability and your ability to get your money quickly out of the bank.

Are ETFs As Liquid As a Savings Account? ETFs are highly liquid—this means you can buy or sell them quickly. These funds can be bought or sold during market hours at the prices found on your brokerage screen. This gives you relatively quick access to your investment capital. Savings accounts are more liquid, allowing you to withdraw or transfer funds as needed—no delays waiting for transfers to and from your brokerage account.

Do ETFs Provide Any Form of Insurance or Protection? Unlike bank accounts protected by FDIC insurance up to $250,000, ETFs don’t come with government-backed insurance. However, you can take steps to help protect your portfolio from significant losses. One common strategy is diversification—the investment version of not putting all your eggs in one basket. For example, instead of buying just one ETF that tracks technology stocks, you might spread your money across different types of ETFs—say, some that track large companies, some that track bonds, and maybe some that track the international markets.

The Bottom Line

A savings account is a safe place to park your cash. Many times, especially when costs are going up quickly, it can also mean losing money. To beat inflation and generate something extra, you generally need to invest in securities, and the ETFs we discussed offer an inexpensive, relatively low-risk way to do this. That said, there is more risk involved, especially with funds that hold stocks. With ETFs, there’s a lot of choice. You can invest in stock indexes, bonds, and even specific sectors.

However, ETFs aren’t for everyone. Before investing in them, you should be aware that ETFs don’t offer guaranteed returns, and you can lose your money.

The best bond ETFs have had a rough few years, that’s for sure. A rising interest-rate environment caused no shortage of disruptions to the typical investor’s portfolio.

What’s more, uncertainty about the Federal Reserve’s monetary policy and the trajectory of inflation amid the second Trump administration’s tariff war has roiled the bond market in the past few months.

There is an inverse relationship between bond funds and yields, because older (and lower-yield) bonds become less attractive as interest rates rise — and are discounted as a result. This has caused many major funds to slip in recent years.

The good news is that many bond ETFs have stabilized and still offer yields that are significantly higher than the stock market, even after the Fed started cutting interest rates.

The simple fact is that bonds remain a key part of any portfolio.

“We still think high-quality bonds play a pivotal role in portfolios as they have shown to be the best diversifier to equity risk,” says Lawrence Gillum, fixed-income strategist at independent broker-dealer LPL Financial .

As Gillum underscores, “It’s best to have that portfolio protection in place before it’s needed.”

To be clear, most investors should never give up on stocks. In the long term, equity investments are an effective path to growing your money, and every diversified portfolio should look across different asset classes.

But it has become increasingly apparent through the years that bonds are an important asset, which many investors might be lacking in their holdings.

With that in mind, here are seven of the best bond ETFs for investors who want to diversify beyond stocks and/or to boost the income potential of their portfolios.

The market is calm for now, but heightened volatility is expected in the coming quarters.

Key Takeaways

The US stock market is trading at only a 3% discount.

Market-weight stocks overall, but overweight value.

There is a minimal margin of safety as compared with risks ahead.

The market is calm for now, but heightened volatility is expected in the coming quarters.

June 2025 US Stock Market Outlook and Valuation

As of May 30, 2025, according to a composite of our valuations, the US stock market was trading at a 3% discount to fair value. Historically, that was close to the midpoint, where half the time the market trades at a higher valuation and half the time at a lower valuation. While we remain market weight at this valuation, we’d prefer to see more of a margin of safety in light of the higher-than-average downside risk potential.

For example, the price/fair value fell as low as a 17% discount to fair value on April 4, 2025. At that level, we recommended that investors move to an overweight position as we thought that the discount was more than enough margin of safety for long-term investors. Following this especially rapid rebound, we moved back to a market weight as valuations closed in on fair value to lock in those quick, short-term gains.

Price/Fair Value of Morningstar’s US Equity Research Coverage at Month-End Source: Morningstar Research Services, LLC. Data as of May 30, 2025.

Is This Just the Eye of the Hurricane?

Last month, we noted that heading into May, we were entering a period of relative calm. Over the past month, the US stock market has become especially sanguine about the heightened risks it will have to face this year. Yet, this calm appears to be more like the eye of the hurricane as opposed to the passing of a single storm.

Tariffs and Trade Negotiations

The on-again/off-again drama regarding trade tariffs and trade negotiations will remain an outstanding risk until negotiations are concluded. Trade negotiations have reportedly begun, yet finalized agreements don’t appear to be anywhere near fruition. Furthermore, legal wranglings within the US have questioned the validity of the tariffs and will be caught up in appeals courts over the short term.

At this point, it’s nearly impossible to determine when trade negotiations will be completed and what the terms of those negotiations will be. While the worst of the tariffs have been paused, we suspect it won’t be until those deadlines approach that new agreements may be finalized. Until then, as news emerges regarding the progress and substance of trade negotiations, these headlines could have an outsize positive or negative impact on markets. For example, other countries could make selective leaks to the media to try to destabilize US markets in order to try to obtain negotiating leverage.

Economic Growth Slowing

Over the next few quarters, we suspect that the economy and corporate earnings will be distorted by several factors. First, the reported gross domestic product for the first quarter of 2025 was negative 0.3%. Yet, the negative print was due to a significant amount of purchasing of foreign goods prior to the implementation of the tariffs. Excluding the impact of these purchases, the real underlying fundamental rate of economic growth would have been positive.

Second-quarter GDP is poised to be skewed to the upside as this effect is reversed. The Atlanta Fed GDPNow estimate for second-quarter GDP is 4.6%, yet Morningstar’s US economics team expects the real underlying fundamental rate of economic growth will slow from the first quarter. Furthermore, our US economics team projects that the rate of real economic growth (excluding heightened imports before the tariffs) will continue to slow sequentially over the remainder of 2025.

Second, we suspect that supply and transportation dislocations will result in numerous disruptions and may lead to accounting adjustments and thus distort earnings. Assuming our economic forecast comes to fruition and the resulting surge in imports causes dislocations, a slowing earnings-growth rate could disappoint investors and lead to a downward recalibration in market valuations.

Rising Yields Making Markets Nervous

Following a weak auction on 20-year US Treasury bonds, there is heightened sensitivity to Treasury yields. If US Treasury yields were to weaken, especially if they were to breach 5%, we expect it would likely lead to a downward adjustment in valuations across the US stock market.

An easing monetary policy does not appear to be in the cards in the near term. According to the CME FedWatch tool, the market is not expecting the Federal Reserve to cut the federal-funds rate anytime soon. It’s not until the September meeting that the market is pricing in a higher than 50% probability for the Fed to cut rates.

And it isn’t just the US bond market that has investors concerned. Yields on long-term Japanese bonds surged higher. The Japanese 40-year bond yield increased almost 120 basis points this year to 3.70% before coming back down to 3.07%. As yields rose and bond prices fell, many investors began to question the amount of embedded losses on the balance sheets of Japanese banks and insurance companies. With the oldest demographic among the developed markets and a debt/GDP ratio above 260%, many investors are questioning how long the Japanese markets can withstand higher interest rates.

Outlook

Over the next few quarters, we wouldn’t be surprised to see higher-than-usual volatility as these variables play out. Additionally, geopolitical risk does not appear to be abating and could add another wild card to the table. If we are correct, and the stock market suffers another selloff, investors may want to keep enough dry powder to move back to an overweight position once valuations warrant such, as we saw at the beginning of April.

Positioning to Ride Out a Potentially Turbulent Market

Based on our valuations, by style, we advocate that investors:

Overweight value stocks, which trade at a 14% discount to fair value.

Market-weight core stocks, which trade at a 1% discount to fair value.

Underweight growth stocks, which trade at an 11% premium to fair value.

By capitalization, we advocate that investors:

Slightly underweight both large- and mid-cap stocks to fund an overweight in small-cap stocks.

Overweight small-cap stocks, which trade at a 20% discount to fair value.

While small-cap stocks remain significantly undervalued, an overweight position here should not be viewed as a short-term trade because it may take a while before market sentiment shifts to a positive view on small caps. Historically, small-cap stocks do best when the Federal Reserve is easing monetary policy, the economy is viewed as bottoming out and poised to start to rebound, and long-term interest rates are declining.

That is not the current environment. Today, the outlook for monetary policy is especially cloudy. Morningstar’s US economics team expects that the rate of economic growth in the US will slow sequentially, and long-term interest rates have largely been range-bound between 4.25% and 4.75% since last November.

Price/Fair Value by Morningstar Style Box Source: Morningstar Research Services, LLC. Data as of May 30, 2025.

Sector Valuations and Takeaways

Technology was the highest returning sector in May, up 10.30%. Following this surge, the sector is now trading near fair value.

Communication services was the second-highest returning sector in May, rising 9.59%. Yet even after this run, it remains the most undervalued sector. Although Meta META rose almost 17%, it remains a 4-star-rated stock at a 16% discount, and Alphabet GOOGL rose 7% in May, and this 5-star stock trades at a 28% discount to our fair value.

Rounding out the three top-performing sectors, consumer cyclical rose 8.86% last month. However, 40% of this gain was generated by Tesla TSLA, which surged 18% in May. Tesla accounts for almost 19% of the sector index’s market capitalization, and as such, its price movement and valuation can heavily skew the sector average. At this point, the valuation of the consumer cyclical sector is back to nearly fairly valued.

Laggards in May included the real estate sector, which only rose 1.02%. The sector valuation was unchanged at a 10% discount to fair value as the return was matched by an equivalent increase in fair values. Similarly, the energy sector remains significantly undervalued at a 14% discount to fair value as the sector only rose 1.58% last month.

The healthcare sector was the only sector to become more undervalued, declining 4.96% in May, making it the only sector to register a loss. Losses from Eli Lilly LLY and UnitedHealth UNH accounted for the preponderance of the sector’s decline.

The consumer defensive sector remains the most overvalued, yet that valuation is skewed into overvalued territory by 1-star-rated Costco COST, 1-star Walmart WMT, and 2-star Procter & Gamble PG. These three stocks account for 31% of the market capitalization of the sector index. Excluding these three stocks, the rest of the sector trades at a more reasonable 6% discount to fair value. The utilities and financial-services sectors are the next two most overvalued sectors. In these sectors, overvaluation is more widespread, and few stocks are rated 4- or 5-stars.

Vanguard Short-Term Corporate Bond Index Fund Admiral Shares

Fund category: Short-term bond

Short-term bond Assets under management: $41.4 billion

$41.4 billion Yield: 4.6%

4.6% Expense ratio: 0.06%

Moving on to the fixed-income side of things, we’ll look at two different bond funds: one focused more on safety, and one focused on pushing the pedal to the high-yield metal.

The Vanguard Short-Term Corporate Bond Index Fund Admiral Shares ( VSCSX ) tracks the Bloomberg U.S. 1-5 Year Corporate Bond Index, which is made up of U.S. dollar-denominated, investment-grade bonds issued by both U.S. and non-U.S. companies, with maturities of between one and five years.

One of the more confusing aspects of the fund is that the index says it only pulls bonds from three sectors: industrials, financials and utilities. And indeed, the weighting is 44.2% financial, 49.5% industrial, 6.2% utilities, and 0.1% “other.”

But if you actually delve into the holdings, you’ll find that there are many, many holdings outside of those sectors. What gives?

Vanguard representatives state that the sectors listed for VSCSX don’t work like normal stock-market sectors. For instance, consumer discretionary stocks might be listed as industrials, and telecoms might be listed as utility stocks .

So you’re actually getting a much wider scope of the corporate bond market than it might seem – indeed, top-10 holdings include bonds from financials including Bank of America (BAC) and Wells Fargo (WFC), but also from health care stocks such as Amgen (AMGN) and AbbVie (ABBV) and telecom Comcast (CMCSA).

The portfolio’s credit quality is good (albeit not spectacular), with 45% of assets in BBB-rated bonds (the lowest investment-grade rating), 47% in A-rated bonds, 7% in AA-rated bonds, and the thin remainder in AAA-rated bonds.

“Many funds in this category have wider mandates that include government and securitized bonds, which the fund omits by definition,” says Morningstar analyst Lan Anh Tran .

“Compared to the category average, the fund consistently underweights Treasuries and agency bonds by a wide margin,” she adds. “This pulls its credit risk profile into more aggressive territory.”

Still, the average effective maturity of the portfolio is a low 2.9 years, which helps tamp down risk. All told, duration is a fairly low 2.7 years.

“[Duration is] a measure of a bond’s interest-rate sensitivity,” say Kiplinger’s Dan Burrows and Anne Kates Smith in their feature on the 10 things to know about bonds .

“As a general rule, for every [1-percentage-point] increase or decrease in interest rates , a bond’s price will change approximately 1% in the opposite direction for every year of duration,” they add.

So in VSCSX’s case, a 1-percentage-point increase in rates would result in a 2.7% decline in the fund’s price, and vice versa. That’s a modest amount of risk for what is a pretty high yield on the Vanguard Short-Term Corporate Bond Index right now.

While we can’t track SEC yield (the optimal measurement for bond funds) over time, we can track trailing 12-month yield. It’s not perfect, but it gives us some historical perspective.

And at least on a TTM yield basis, VSCSX is delivering more yield than it has since its 2010 inception.

That makes Vanguard’s short-term corporate bond fund both an ideal hiding place for cash you’re waiting to deploy, and even a lower-risk source of decent yield if you’re investing for retirement .

VSCSX is also available in ETF format: The Vanguard Short-Term Corporate Bond ETF (VCSH), which charges 0.03%.