Tax-Free Income vs. Treasury Safety: Inside VGSH and SMB ETFs

Vanguard Short-Term Treasury ETF (NASDAQ:VGSH) and VanEck Short Muni ETF (NYSEMKT:SMB) differ most in their underlying bond exposure—Treasuries versus municipal bonds—along with notable contrasts in yield, assets under management, and trading liquidity.

Both VGSH and SMB target the short end of the bond market, seeking modest price fluctuation and reliable income. This comparison explores whether exposure to U.S. government debt or tax-exempt municipal bonds makes more sense for investors focused on cost, risk, and recent performance.

Snapshot (cost & size)

Beta measures price volatility relative to the S&P 500; beta is calculated from five-year weekly returns. The 1-yr return represents total return over the trailing 12 months.

VGSH is more affordable with a 0.03% expense ratio, undercutting SMB’s 0.07%, and also delivers a higher yield, paying 4.0% versus SMB’s 2.6%—a meaningful gap for income-focused investors.

Performance & risk comparison

What's inside

SMB targets the short-term municipal bond market, investing in 334 holdings that are all tax-exempt and primarily investment-grade. VGSH, by contrast, holds only U.S. Treasury securities—93 in total—providing pure government-backed exposure and eliminating credit risk from states or municipalities. Both funds show a 100% allocation to cash and equivalents in sector breakdowns, but the underlying credit quality and taxation treatment differ substantially.

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What this means for investors

Both ETFs offer short-term stability for conservative portfolios, but you're lending to fundamentally different borrowers. VGSH holds U.S. Treasury bonds with 1-3 year maturities, which are essentially IOUs from the federal government. SMB, by contrast, invests in short-term municipal bonds issued by states and cities to fund infrastructure projects like schools and roads. For investors, the critical differences are tax treatment and credit risk.

VGSH has a rock-bottom 0.03% expense ratio and massive $30 billion in assets, giving it excellent liquidity. Its Treasury interest is federally taxable but exempt from state taxes. SMB charges 0.16% with a more modest $295 million in assets, but that income is federally tax-exempt and often state tax-exempt if you live where the bonds were issued (take the time to research your situation). For investors in high tax brackets, SMB's lower nominal yield can actually deliver higher after-tax returns.

If you prioritize absolute safety and superior liquidity backed by the full faith of the U.S. government, VGSH makes the most sense here. Investors in a high tax bracket seeking tax-advantaged income and comfortable accepting modest municipal credit risk for potential after-tax advantage may find more opportunity with SMB.

Sara Appino has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.