Ginnie Mae Funds for Your Retirement

Many people prefer to have some conservative holdings in their IRAs and other retirement accounts. This century has already produced two nasty bear markets (in 2000–2002 and 2007–2009). If a third downturn occurs, investors will be glad they held some defensive positions, which might minimize losses and possibly offer gains.

When it comes to playing defense, Ginnie Maes may merit consideration. The nickname comes from the formal name, Government National Mortgage Association, or GNMA. This agency promises investors the payment of principal and interest from residential mortgage loans insured or guaranteed by federal entities, such as the Federal Housing Authority and the Department of Veterans Affairs. Ginnie Mae mortgage bonds are the only mortgage securities with full federal backing.

It’s complicated

Ginnie Mae securities might be considered the “safe option” for retirement investing. Yields are not enormous in today’s environment, but they may be relatively attractive. Typically, Ginnie Maes pay one to two percentage points of yield more than Treasuries. Why should supposedly safe Ginnie Maes pay more?

One answer rests with mortgage-backed securities. Most bonds lose value when interest rates rise but gain value when rates fall because their fixed yields become more attractive.

Mortgage-backed securities, including Ginnie Maes, also suffer losses when rates rise. However, rising rates can cause a slowdown in mortgage pre-payments because borrowers are less likely to refinance their loans. This slowdown means that Ginnie Mae investors have less money to reinvest at higher yields.

The opposite phenomenon affects mortgage securities when rates fall. More refinancing occurs as homeowners seek the lower loan rates. That means more cash flow to investors holding mortgage bonds and more money to reinvest at lower rates. Thus, mortgage-backed securities may lose more than conventional bonds when rates rise and gain less when rates fall.

Taxes, too

Treasury securities and funds holding them pay interest that’s taxable at the federal level, but is generally exempt from state and local income taxes. Therefore, these holdings can be especially attractive to investors in high-tax areas.

Mortgage-backed securities, even federally backed Ginnie Maes, do not enjoy state or local tax exemption; they’re fully taxable at all levels of government. This relative disadvantage, along with the complexity and interest rate threats, may explain the higher yields (versus Treasuries) that Ginnie Maes offer to investors. Their tax treatment also might cause Ginnie Maes to be an appealing holding in retirement accounts where all the income taxes can be deferred until money is withdrawn.

Favoring funds

Investors can often purchase individual Ginnie Mae bonds for around $25,000. Some retirees are pleased with these “pass-through” securities because they deliver monthly cash flow, reflecting the regular payments made on the underlying mortgages by homeowners. If you work with a savvy financial adviser or if you are willing to research Ginnie Maes on your own, this can be an astute choice.

That said, the Ginnie Mae market is complex, likely to lead to missteps by novice investors. Many people prefer owning shares of a fund and relying on the expertise of professionals to choose suitable Ginnie Maes. Diversification and a lengthy time frame might overcome interest rate concerns and deliver the benefits of relatively high yields. Many leading fund families, including Vanguard, Fidelity, and T. Rowe Price, have established Ginnie Mae mutual funds with performance records for investors to evaluate.

In terms of performance, Ginnie Mae funds generally had positive returns in 2008 when the stock market nosedived. The past is no guarantee of future results, but an encouraging track record might indicate that Ginnie Mae may be worth a place in a retirement portfolio.