“Through Vanguard, I have the GNMA fund. I’m concerned about maintaining it because interest rates appear to have nowhere to go except up, and the basic rule is that bonds fall when interest rates rise. But does the same hold true for GNMA bonds?”
What Are GNMA Bonds (GNMAs)?
The Government National Mortgage Association (a.k.a. Ginnie Mae) issues mortgage-backed securities that are insured by the federal government. For individuals unfamiliar with mortgage-backed securities, Vanguard offers the following explanation:
“MBS are investments in a pool of mortgage loans, which serve as the underlying asset and provide the securities with cash flow. Because the principal and interest of the underlying mortgage loans “passes through” to the investor, MBS are usually referred to as “pass-through” instruments. Over the life of the security, all bondholders receive a monthly pro-rata distribution of principal and interest.”
The fact that GNMAs (and other mortgage-backed bonds) behave differently than other bonds is vital to understand.
When interest rates rise, GNMAs behave similarly to other bonds in that their prices fall.
When interest rates fall, GNMAs behave differently. People tend to payback their mortgages as interest rates drop (via refinancing). This forces the fund to reinvest its cash in new (lower-yielding) bonds because (a portion of) the principal of GNMAs gets returned before maturity.
This indicates that the price appreciation of GNMA funds is limited in comparison to the price appreciation of other bond funds during periods of dropping interest rates. Note that this does not imply that when interest rates fall, the price of a GNMA fund will fall as well. Simply put, the price will most likely not rise at the same rate as the prices of other similar-duration bond funds.
To put it another way, GNMAs have the same downside as regular bonds, but they have a limited potential. GNMAs have higher yields than Treasury bonds of equal term in return for this limited upside.
Do GNMAs Have a Role in a Portfolio?
When it comes to bonds, the market is generally efficient, which means that most bonds generate returns that are proportional to their amount of risk over time. That is, it is difficult to discover anything that is very cheap in comparison to other bonds.
As a result, I don’t have strong thoughts about which bonds to employ unless you have a special aim in mind other than the conventional goal of decreasing the volatility of an otherwise-stock portfolio*. To put it another way, the most important thing, in my opinion, is to ensure that the portfolio’s overall risk profile is acceptable for your needs (e.g., by using a lower overall allocation to stocks if you decide to use higher-risk bonds).
- Given a 5-year average term and a reasonable amount of interest rate risk (approximately similar to Vanguard’s “total bond” fund),
- Prepayment risk (albeit, as previously stated, this isn’t actually a risk of loss, but rather a risk in the sense that the fund’s upside is limited and the fund’s SEC yield isn’t always a strong indicator of future returns).
GNMAs operate differently than regular bonds, but I believe they can be a good addition to a portfolio. However, I can’t conceive of a single financial purpose for which GNMAs would be a better fit than other bonds.
*Inflation risk can be reduced by using TIPS, or tax efficiency can be improved in a taxable brokerage account by using muni bonds and/or Treasury bonds.
What is the frequency of GNMA bond interest payments?
Ginnie Mae I, or GNMA I MBS, is made up of mortgages that pay principle and interest on the fifteenth of each month, while Ginnie Mae II, or GNMA II MBS, pays principal and interest on the twentieth.
Is it possible to lose money on GNMA?
There is, however, a technique to avoid this. If you’re offered a GNMA fund with an abnormally high current yield, it’s likely to have a portfolio full of high-cost mortgage securities. Van Kampen U.S. Mortgage A shares, for example, were recently distributing at a 5.39 percent annual rate. The fund’s 30-day SEC yield was only 2.73 percent at the time, indicating the amortization of premiums paid. For years, Van Kampen U.S. Mortgage has followed this strategy. As a result, the fund’s overall return has been lower than funds that do not follow this approach.
For example, Vanguard GNMA was distributing at a much lower rate of 4.67 percent, which was extremely near to its 30-day SEC yield of 4.57 percent.
Q. We have around $60,000 in the Vanguard GNMA fund and are automatically investing $1,000 each month. This is a cash reserve fund for us, thus it needs to be kept as liquid as possible. The Vanguard Inflation Protected Securities mutual fund recently sent me a prospectus. Please compare the advantages and disadvantages of each in a rising interest rate environment, bearing in mind our short-term goal.
A. The well-managed GNMA funds are distinguished from normal bond funds by their greater yield relative to their effective maturity. The Vanguard GNMA fund is the largest of the intermediate-term government bond funds, with about $19 billion in assets. Over the last 12 months, 3 years, 5 years, 10 years, and 15 years, it has performed in the top 17, 13, 15, 6, and 3 percentiles of its intermediate maturity class, respectively. As a result, it is a suitable option for consumers looking for a higher return on money they may require access to. It has generated an annualized return of 6.81 percent over the last five years, for example.
However, it is possible to lose money in a GNMA fund, even if it is as good as Vanguard GNMA. The fund lost 0.95 percent in 1994, one of the worst years for fixed income investment in history. The portfolio only returned 2.49 percent in 2003, a year marked by mortgage angst. It was still in the top 25% of its category in both years.
Over the last 12 months and three years, the Vanguard Inflation Protected Securities fund (ticker: VIPSX) has delivered a better total return (7.28 and 9.83 percent, respectively, compared to 4.16 and 5.03 percent for Vanguard GNMA). Those impressive returns should not be considered long-term. The initial issues of Treasury Inflation Protected Securities were met with skepticism by the investment community. As a result, they had to be priced at a 3.5 percent inflation premium. Because investors now have a better understanding of the bonds, the premium has been significantly lowered. As a result, future returns are expected to be lower.
Neither of these funds is a good choice for a cash reserve. The GNMA fund will most likely be more beneficial to you.
Do GNMA bonds make monthly payments?
The Government National Mortgage Association (GNMA or Ginnie Mae) produces agency bonds that are backed by the United States government’s full faith and credit. Mortgage-backed securities (MBS) backed by loans insured by the Federal Housing Administration and the Department of Veterans Affairs are guaranteed by the GNMA. The minimum denomination of new GNMAs is $25,000.
MBS are investments in a pool of mortgage loans that serve as the underlying asset and provide the securities with cash flow. Because the principal and interest of the underlying mortgage loans “passes through” to the investor, MBS are usually referred to as “pass-through” instruments. Over the life of the bond, all bondholders get a monthly pro-rata distribution of principal and interest. MBS are issued with maturities ranging from one to thirty years, however the majority mature sooner.
Each MBS has a “average life,” which is a calculation of how much time is left until the final principal payment. Changes in principle payments, which are influenced by interest rates and the speed with which mortgage holders prepay their loans, will affect the average life.
- GNMA securities, like US Treasuries, are guaranteed and backed by the US government’s full faith and credit, and are typically regarded as having the greatest credit grade.
- When GNMA securities are sold or redeemed, investors may be subject to capital gains taxes.
- For more information, investors should speak with a tax professional.
- GNMA bonds are not traded by Vanguard Brokerage Services. Vanguard Brokerage can help you sell your GNMAs before they mature by connecting you to a secondary over-the-counter market. Liquidity for GNMA bonds is normally provided by the secondary market, however it varies depending on the attributes of the bond, the lot size, and other market factors. It may be difficult to sell GNMAs that have had a large principal reduction.
- In both the primary and secondary markets, Vanguard Brokerage charges a commission for GNMA transactions.
- Interest rates can cause GNMA prices to rise or fall. The market price of outstanding GNMA bonds will normally fall when interest rates rise. Interest rate changes have a secondary impact on MBS since they influence mortgage prepayment rates. The average life and yield of a mortgage pool are affected by the prepayment rate. Because mortgage holders can refinance at cheaper rates, prepayments generally accelerate when interest rates fall. Prepayments tend to be slowed as interest rates rise.
- If mortgage holders pay off their debts early, the principal may be refunded to bondholders sooner than expected. Bondholders may therefore be forced to reinvest the recovered principle at a lower rate of interest.
- If mortgage holders postpone prepayment of their loans, principal may be refunded to bondholders later than intended. Bondholders may thus miss out on the chance to reinvest the refunded principal at a higher rate.
- All bonds entail the risk of the issuer defaulting or being unable to make timely interest and principal payments. GNMAs, on the other hand, have a low credit risk because they are backed by the US government.
- Prior to maturity, GNMAs can be sold for a significant profit or loss. The secondary market may be restricted as well.
Is it safe to invest in GNMA?
In comparison to other types of bonds and debt instruments, GNMA funds are considered low-risk products. Despite this, these funds subject investors to risks like as inflation and refinancing risk.
Are GNMA bonds a safe investment?
Any privately issued mortgage-backed product that is insured by the Government National Mortgage Association (GNMA) for timely principle and interest payments is referred to as a GNMA bond. They are the only mortgage-backed securities backed by the US government’s full faith and credit. The Government National Mortgage Association (GNMA), usually known as Ginnie Mae, is a wholly owned government corporation that was founded in 1968 to guarantee mortgage-backed securities for single-family and multi-family loans insured by various government agencies.
Is GNMA a Federal Housing Authority?
This isn’t just any loan that comes with such a strong guarantee. The Federal Housing Administration (FHA) insures Ginnie Mae MBSs, which primarily provides mortgages to low-income and first-time home buyers, among other neglected populations.
Securities backed by loans insured by a variety of programs are covered by the Ginnie Mae guarantee:
- Single-family and multifamily mortgage insurance programs are offered by the Federal Housing Administration (FHA).
- Rural Housing Service loan guarantee programs are managed by the United States Department of Agriculture.
Each of these loan programs has its own set of rules to ensure that the loans are given to the people who need them the most.
Ginnie Mae is a few stages removed from the process because of her function as a backer. The agency does not originate loans, provide finance for mortgage issuers, or even set rules for loan issuers as a “bystander.”
Is a GNMA ETF available?
The Government National Mortgage Association (‘GNMA’ or ‘Ginnie Mae’) guarantees mortgage-backed pass-through securities, and the iShares GNMA Bond ETF tries to replicate the investment performance of that index.
What risks does investing in a GNMA not entail?
As a result, Option D is inaccurate. What are the advantages and disadvantages of investing in a GNMA? A security’s principal value is constant and does not change. The market value of the security will fluctuate due to interest rate changes in the market.
What exactly is a FNMA bond?
Bonds issued by government-sponsored enterprises (GSEs) or US government agencies are known as US government agency bonds. GSEs are non-profit organizations founded with a public purpose and funded by the federal government. Typically, agency bonds are issued in $1,000 denominations.
The Federal Home Loan Banks (FHLB) and the Federal Farm Credit Banks (FFCB), which are regional bank systems, are examples of GSEs. The Federal National Mortgage Association (FNMA or Fannie Mae) and the Federal Home Mortgage Corporation (FHLMC or Freddie Mac) are privately held businesses established by the federal government to provide liquidity and expand credit availability in the mortgage industry.
Federal institutions such as the Government National Mortgage Association (GNMA or Ginnie Mae) are backed by the United States government’s full faith and credit. Mortgage pass-through securities are frequently used to issue GNMAs.
- The government of the United States does not guarantee GSE debt. GSE debt is completely the issuer’s responsibility, and hence has a higher credit risk than US Treasury securities.
- Interest earned on agency bonds is normally taxed at both the federal and state levels.
- State taxes are not levied on interest on some agency bonds, such as those issued by the FHLB and FFCB.
- When agency bonds are purchased at a discount, they may be subject to capital gains taxes when sold or redeemed. For more information, investors should speak with a tax professional.
- GSE or agency bonds are not traded by Vanguard Brokerage Services. Vanguard Brokerage can provide access to a secondary over-the-counter market if you wish to sell your GSE or agency bonds before they mature. Liquidity for GSE or agency bonds is normally provided by the secondary market, however liquidity varies based on a bond’s attributes, lot size, and other market conditions. It may be difficult to sell GNMAs that have had a large principal reduction.
- Vanguard Brokerage may receive a concession from the issuer on new issue agency bonds purchased in the primary market. Vanguard Brokerage has the right to levy a commission if a concession is not available. Transactions in the secondary market will be subject to commissions.
- Interest rates can cause the price of agency bonds to rise or fall. Long-term bond prices are more affected by interest rate movements than short-term bond prices.
- All agency bonds are subject to the risk that the issuer will default or be unable to make timely interest and principal payments. GSE debt is completely the issuer’s responsibility, and hence has a higher credit risk than US Treasury securities.
- Call provisions on some agency bonds allow the issuer to redeem the bonds before the stated maturity date. During periods of falling interest rates, issuers are more likely to call bonds.
- Economic, political, legal, or regulatory changes, as well as natural calamities, can have an impact on a GSE or agency issuer’s financial status and capacity to make timely payments to bondholders. Event risk is unpredictable and has the potential to have a major impact on bondholders.
- Agency bonds that are sold before their maturity date may be liable to a significant gain or loss. The secondary market may be restricted as well.
What are the taxes on GNMA?
The interest you earn on a GNMA mortgage-backed bond is fully taxable on your federal and state tax returns. At the end of the year, your investment broker will send you a 1099-INT stating how much interest you received from your bonds, and that interest will be reported on your tax returns as taxable income. The interest will be taxed at the same rate as your ordinary income tax.