Short Term Government Bonds Explained

Higher yields, Fed policy and Fitch Ratings shine a light on short term government bonds.

Research Lead
Reviewed by: Lisa Barr
Edited by: Lisa Barr

Is now a good time to invest in short-term government bonds? Inflation is falling but it’s still stubbornly high and the Fed just raised rates to its highest level in 22 years. Adding fuel to the fire of higher short-term bond yields is Fitch Ratings’ recent downgrade of U.S. debt from AAA to AA+.  

Now is a good time to brush up on your short-term government bond knowledge and determine if these fixed income securities are a good fit for your portfolio. 

What Are Short Term Government Bonds? 

Short-term government bonds are debt securities issued by a government with a relatively short maturity period, typically ranging from a few months to a few years. These bonds are considered to be low-risk investments because they are backed by the full faith and credit of the government issuing them.

Short-term government bonds are a popular choice for investors who want to preserve their principal investment while earning some interest over a short period of time. 

What Are the Types of Short Term Government Bonds? 

Short-term government bonds come in various forms, such as U.S. Treasury bills and emerging market bonds, and their specific names and characteristics may vary from one country to another.

Here are some common types of short-term government bonds: 

  • Treasury bills (T-bills): T-bills are short-term government securities issued by the U.S. Department of the Treasury. They have maturities of four, 13, 26 or 52 weeks (one year) and are sold at a discount to their face value. When the T-bill matures, the investor receives the full face value. The difference between the purchase price and the face value is the investor's return. 
  • Short-term Treasury notes (T-notes): These are similar to T-bills but have slightly longer maturities. Treasury notes can have maturities of two, three, five or seven years in the United States. They pay interest semiannually and return the principal amount at maturity. 
  • Eurozone bonds: In the Eurozone, short-term government bonds issued by member countries are collectively known as "bills of exchange" or "bills of Treasury." These include instruments like French Treasury bills (BTF), German Treasury discount papers (Schatz) and Italian Treasury bills (BOT), among others. 
  • Emerging market bonds: Short-term government bonds are also issued by emerging market economies, such as China and India. These bonds may have different names and characteristics depending on the issuing country. 

How Are Short Term Government Bonds Taxed? 

The taxation of short-term government bonds varies depending on the country in which the bonds are issued and the tax laws that apply. In the U.S., interest from government bonds is generally taxed as income at the federal level but tax-free at the state and local level. The interest income earned from short-term government bonds is reported on Form 1099-INT. 

Here's how short-term government bonds are generally taxed in the U.S.: 

  • Interest income: The interest income earned from short-term government bonds is subject to federal income tax. This income is typically taxed at your ordinary income tax rate, which is determined by your total taxable income, including the interest earned from the bonds. 
  • Capital gains: Short-term government bonds are typically issued at a discount to their face value, and when they mature, the difference between the purchase price and the face value is treated as interest income for tax purposes. If you sell short-term government bonds before maturity at a price higher than your purchase price, the difference may be considered a capital gain and subject to capital gains tax. 
  • Tax-advantaged accounts: Short-term government bonds, like other U.S. Treasury securities, are often considered very safe investments and are commonly held in tax-advantaged retirement accounts such as individual retirement accounts (IRAs). Interest income earned within these accounts is not subject to current taxation, allowing for potential tax deferral until you withdraw funds from the account. 

How Do Interest Rates Affect Short Term Government Bonds? 

Interest rates have a significant impact on the performance and attractiveness of short-term government bonds. The relationship between interest rates and bond prices is inversely proportional, meaning that as interest rates rise, bond prices tend to fall, and vice versa. This principle, known as the interest rate risk, applies to short-term government bonds as well.  

Here's how interest rates affect short-term government bonds: 

  • Price sensitivity and coupon rate: When interest rates in the broader economy rise, newly issued bonds start offering higher coupon rates to attract investors. As a result, existing short-term government bonds with lower fixed coupon rates become less attractive to investors. Their market prices decrease to align with the higher yields available in the market. 
  • Yield curve flattening/steepening: Changes in short-term interest rates can impact the overall shape of the yield curve. A flattening yield curve, where short-term rates rise more than longer-term rates, can lead to more significant price declines for short-term bonds. Conversely, a steepening yield curve occurs when longer-term interest rates rise more than short-term rates.  
  • Investor behavior: Short-term government bonds are often considered safer investments, especially during periods of economic uncertainty. When interest rates rise due to improving economic conditions, investors may rotate toward riskier assets seeking higher returns. This shift in investor sentiment can reduce demand for short-term government bonds and put downward pressure on their prices. 
  • Reinvestment risk: When short-term government bonds mature or their interest payments are received, investors may face reinvestment risk in a rising interest rate environment. They might have to reinvest their funds at lower prevailing rates, potentially leading to lower returns on their investments. 

What Are Short Term Government Bond ETFs?

Short-term government bond ETFs are a type of exchange-traded fund that invests in short-term government bonds. These bonds have maturities of less than five years, which means that they will mature and be repaid within that time frame. These ETFs track different indexes of short-term government bonds, so they may have different risk and return profiles. 

Some of the most popular short-term government bond ETFs include: 

Pros & Cons of Short Term Government Bonds 

Short-term government bonds offer a range of benefits, including safety and stability, but investors should be aware of the potential risks, such as lower returns and inflation risk. Understanding the pros and cons can help you make informed investment decisions based on your financial goals and risk tolerance. 

Pros of Short Term Government Bonds 

  • Safety and stability: Short-term government bonds are generally considered low-risk investments because they are backed by the government's ability to tax and print money. This provides a level of safety and stability, making them suitable for conservative investors. 
  • Predictable income: These bonds offer regular interest payments, providing a predictable income stream for investors. The fixed coupon payments can help meet short-term cash flow needs. 
  • Liquidity: Short-term government bonds are often more liquid than longer-term bonds. They can be easily bought or sold in the market without significantly impacting their prices. 
  • Lower interest rate risk: Short-term bonds have shorter maturities, which means they are less sensitive to changes in interest rates compared to longer-term bonds. This can reduce the potential impact of rising interest rates on the bond's market value. 
  • Diversification: Including short-term government bonds in a diversified investment portfolio can help spread risk and reduce overall portfolio volatility. 

Cons of Short Term Government Bonds 

  • Lower long-term returns: Short-term government bonds can offer attractive yields in the short term, but they typically produce lower returns in the long term compared to other investments, such as stocks or corporate bonds. 
  • Inflation risk: The fixed interest payments from short-term government bonds may not keep up with inflation over time, potentially eroding the purchasing power of your investment. 
  • Opportunity cost: Choosing short-term government bonds over potentially higher-yielding investments might mean missing out on better returns during periods of economic growth or favorable market conditions. 
  • Interest rate risk: While short-term bonds are less sensitive to interest rate changes than long-term bonds, they are still affected by shifts in the interest rate environment. Rising interest rates can lead to lower bond prices. 

Bottom Line on Investing in Short Term Government Bonds 

Short-term government bonds can play a role in providing stability and income within a diversified portfolio, but they may not be suitable for every investor or every market condition. Investors in short-term government bonds should closely monitor interest rate trends and consider how changes in rates could affect their investment strategies. For investors wanting diversified exposure in a single, low-cost investment, short-term bond ETFs can be a smart choice. 

Kent Thune is Research Lead for, focusing on educational content, thought leadership, content management and search engine optimization. Before joining, he wrote for numerous investment websites, including Seeking Alpha and Kiplinger. 


Kent holds a Master of Business Administration (MBA) degree and is a practicing Certified Financial Planner (CFP®) with 25 years of experience managing investments, guiding clients through some of the worst economic and market environments in U.S. history. He has also served as an adjunct professor, teaching classes for The College of Charleston and Trident Technical College on the topics of retirement planning, business finance, and entrepreneurship. 


Kent founded a registered investment advisory firm in 2006 and is based in Hilton Head Island, SC, where he lives with his wife and two sons. Outside of work, Kent enjoys spending time with his family, playing guitar, and working on his philosophy book, which he plans to publish in the coming year.