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Question:
I don't want anything to do with the stock market any
more, and I can't see putting money in CDs. The rates
are so low. I've had money in a
Ginnie Mae
fund. Can I continue to count on it?
Answer:
There has been a lot of chatter about the stock market
being risky. But now is the time to pay attention to
risks in bonds, too, including
Ginnie Maes
.
At first,
you could conclude there is no risk in
Ginnie Mae
bonds. The bonds are created out of mortgages. The
mortgages from many homeowners are pooled, and bond
investors are paid as homeowners make their payments.
Because
the government guarantees that the interest and
principal will be paid on
Ginnie Maes
, there is virtually no risk, even though many people
can't pay mortgages.
"After
Treasurys, Ginnies are the next safest," said
Daniel Hall
, a principal in portfolio review for
Vanguard Group
.
But with
bonds — whether
Ginnie Maes
, Treasurys, municipal bonds or corporate bonds —
there is another way to lose money: If interest rates
start to climb, you can lose money on the bonds.
Recently,
Ginnie Maes
have been yielding more than 4 percent. Meanwhile, many
CDs are paying 2 percent, and 10-year Treasurys are a
little over 3 percent.
But this
is an unusual period. The likelihood of interest rates
staying at these low levels is remote. So when investors
can earn more on bonds, they are not going to want
low-interest individual bonds or the low-interest bonds
in your
Ginnie Mae
bond fund.
Consider
when CDs and Treasurys start paying 6 percent or more,
as they have in the past. Your
Ginnie Maes
yielding 4 percent won't look as good to you then
because you will want to earn more interest. And they
won't look good to other investors.
So the
value of your
Ginnie Maes
could fall. If you hold onto them until they mature, you
won't lose money, although you will settle for the low
interest assigned to them. But if they are in a
Ginnie Mae
fund, the value of your fund will likely fall because
the fund will be loaded with low-interest bonds when
investors can find other, higher-interest bonds.
Hall
notes that in 1994, as rates climbed sharply, the total
return on
Ginnie Maes
declined 0.95 percent.
If this
happens again, your bond fund won't be a loser forever,
because the fund manager will start buying
higher-interest bonds. But if you have been using a
Ginnie Mae
fund like a savings account, and need the money when
values are down, you could take a loss.
This
doesn't mean to avoid
Ginnie Maes
completely. They are often considered a solid part of a
diversified bond portfolio, along with U.S. Treasurys
and high-quality corporate bonds. But do not put all
your cash into a
Ginnie Mae
fund if you plan to use it for living expenses over the
next couple of years.
"Some
people view these as a money market substitute, and they
aren't," Hall said.
There
also is "prepayment risk." Recently, people
have had difficulty refinancing mortgages.
But a big
risk to
Ginnie Mae
investors normally is the risk that interest rates will
fall and people will refinance their mortgages. When
this happens, investors receive their money back and
have to reinvest it at a time when interest rates are
low. So they end up earning less interest than they
thought they would.
Because
of this risk, investors in
Ginnie Maes
typically earn higher interest than they do on U.S.
Treasurys.
But
realize that when you see a rate higher than on another
bond, it's to entice you to take more risk. And realize
that the government is playing a huge role in propping
up the mortgage market by buying and guaranteeing
mortgages. Eventually, it will do less, and, Hall said,
that could affect the value of mortgage-related
securities as investors react to the new environment.
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