High Yields, On The House

If you’re concerned that higher interest rates will devalue bonds this year, Uncle Sam has a deal for you. Securities guaranteed by the Government National Mortgage Association, called GNMA securities or Ginnie Mae securities, are about as safe as Treasury bonds and have shown higher yields.

Ginnie Mae investments work like this: When you take out a mortgage to buy a home, your loan obligation and those of other borrowers are combined to form a larger pool that is then sold to investors. The Government National Mortgage Association guarantees these mortgage-backed securities with the full support of the federal government. This allows Ginnie Mae investors to assume the role of mortgage lenders without any of the risks.

Additionally, “Ginnie Maes generally offer better yields than straight Treasuries,” says Bill Henderly, CFA, chief investment officer for Professional Planning Consultants in Columbus, Ohio. As of this writing, for example, 10-year Treasuries were yielding around 4.11% versus Ginnie Maes, which were yielding more than 5%.

Not only are Ginnie Mae yields appealing, their volatility tends to be low. That’s because Ginnie Mae investors generally receive some principal payments from homeowners, and those payments can be reinvested at higher yields if interest rates are moving up. For example, the Vanguard GNMA (VFIIX) fund, which has $19 billion in assets, has posted only one calendar-year loss in the past decade — a mere 0.95% drop in 1994 when the overall bond market slumped. “We use Vanguard GNMA, which has extremely low expenses, and PIMCO GNMA (PAGNX) because the company is known for its fixed-income expertise,” says Tom Grzymala, a consultant at Alexandria Financial Associates in Alexandria, Virginia. “These funds are steady income generators with greater stability than other bond funds, perhaps with the exception of Treasury funds.” Grzymala suggests that investors who have 30% of their portfolio invested in fixed-income funds might want to invest 5% to 8% of their overall portfolio in Ginnie Mae funds.

Ginnie Mae funds generally have performed well, but there are drawbacks. When mortgage rates plunge and homeowners refinance, investors receive large amounts of prepayments, which must be reinvested at lower yields. That doesn’t seem to be a problem now, with most forecasts calling for stable or slightly higher mortgage rates this year. In addition, the interest received by Ginnie Mae investors is fully taxed, so these funds generally work better in a tax-deferred retirement account.

TOP GNMA FUNDS RANKED BY 3-YEAR ANNUAL RETURN