Advertisement
investing

Bond Basics: U.S. Agency Bonds

These investments are close enough to government bonds in terms of safety, but make sure you're aware of the risks.

Bonds help add diversity to your portfolio and control risk. But they can be complicated. We can help you understand the basics and make bonds work for you.

A number of U.S. government agencies and federally sponsored enterprises issue debt securities. They usually do not carry the full faith and credit of the government, but this difference is really quibbling because it's doubtful that the government would allow one of its agencies to default on an obligation.

Advertisement - Article continues below

Nevertheless, the difference is usually reflected in the relative yields of agency versus Treasury debt instruments. Agency issues, being the "inferior" risk, pay a bit more, despite the additional fact that some agency securities — but not all — are exempt from state and local income taxes, just like Treasury issues.

A description of the various securities available would amount to a description of the issuing agencies' functions. Some issue short- as well as long-term debt instruments. Most float mainly intermediate-term issues. Minimum-purchase requirements vary greatly, ranging from $1,000 to $25,000. Purchases must usually be made through brokers, who can supply a listing of the securities available.

Ginnie, Fannie, and Freddie: Mortgage-Backed Securities

Among the most popular of agency securities are those backed by the Government National Mortgage Association, or Ginnie Mae, which helps create a secondary market for home mortgages.

Advertisement
Advertisement - Article continues below

Ginnie Mae securities are called pass-through certificates and come in minimum denominations of $25,000. But for as little as $1,000, you can buy into a Ginnie Mae mutual fund or unit trust.

Advertisement - Article continues below

Freddie Mac participation certificates (issued by the Federal Home Loan Mortgage Corp.) and Fannie Mae securities (issued by the Federal National Mortgage Association) come in denominations starting at $1,000.

Mortgage-backed securities can be a solid addition to an investment portfolio, but many investors don't seem to understand the risks. As with bonds, their market value declines as interest rates rise. But Ginnies, Fannies, and Freddies carry another risk: As mortgage rates go down and homeowners refinance, their mortgages get paid off and drop out of the pool. Investors get the principal back, but the lucrative return goes up in smoke. This has the perverse effect of driving the price of Ginnie Maes and similar issues down at the very time that the price of bonds is going up.

Meanwhile, because you're at the mercy of thousands of homeowners making independent decisions about when to refinance, the principal comes back to you in unpredictable chunks. Your cash flow is erratic and so is your yield. To compensate for this uncertainty, mortgage pools have generally had to pay a percentage point or two more than Treasury bonds, which are much more predictable.

Advertisement

Most Popular

65 Best Dividend Stocks You Can Count On
stocks

65 Best Dividend Stocks You Can Count On

These 65 Dividend Aristocrats are an elite group of dividend stocks that have reliably increased their annual payouts every year for at least a quarte…
July 8, 2020
8 Ways You Might Be Cheating on Your Taxes
taxes

8 Ways You Might Be Cheating on Your Taxes

Don't fall into these common traps that can get you in hot water with the IRS.
July 8, 2020
Find a Great Place to Retire
happy retirement

Find a Great Place to Retire

Our cities provide plenty of space to spread out without skimping on health care or other amenities.
July 2, 2020

Recommended

2020 Stock Market Holidays and Bond Market Holidays
Markets

2020 Stock Market Holidays and Bond Market Holidays

Is the market open today? Take a look at which holidays the stock markets and bond markets take off in 2020.
July 10, 2020
65 Best Dividend Stocks You Can Count On
stocks

65 Best Dividend Stocks You Can Count On

These 65 Dividend Aristocrats are an elite group of dividend stocks that have reliably increased their annual payouts every year for at least a quarte…
July 8, 2020
13 Best Vanguard Funds for the Next Bull Market
mutual funds

13 Best Vanguard Funds for the Next Bull Market

Optimistic that the bounce since March is indeed the start of the next bull market? Here are the 13 best Vanguard funds to help you make the most of i…
July 7, 2020
3 Municipal Bond Funds for Rich, Tax-Friendly Yields
Investing for Income

3 Municipal Bond Funds for Rich, Tax-Friendly Yields

Municipal bond funds allow you to enjoy the benefits of tax-exempt income. By investing CEFs, you can sweeten the pot even further.
July 2, 2020