Case in point:
Wall Street uses its creative juices toslice, dice, and package securities ina variety of ways to persuade investors toplace their savings dollars in products thatare hot at the time, but can quickly turnsour. Without any forethought as to whensomething looks too good to be true,investors have flocked to investmentproducts created by the brilliant minds ofWall Street wizards, losing sight of thefact that there are no free lunches, andsomething that looks too good to be trueusually is. Ginnie Maes.
VOLATILE MORTGAGE POOLS
The Government National MortgageAssociation (GNMA) issues its mortgage backedsecurities (Ginnie Maes) in theform of pools, or "pass-through" securities.These mortgage pools, with the fullfaith and credit of the Treasury (AAA/AAA), seem to be offered at very attractiverates of interest to investors. Thereare several issues for physician-investorsto be aware of, though.
Generally speaking, fixed-interest investmentvehicles have higher interestrates the more long term they are. That'snot without reason. When interest ratesmove up and down, the more long termthe security, the greater the price fluctuationof those investments will be. Short-termbonds don't move much; long-termbonds move in price swings 5 to 10 timesgreater than short-term bonds. Ginnie Maes can be very volatilewhen interest rates fluctuate.
The end result:
The second factor that plays againstinvestors is that GNMA securities aremortgage-backed, and what affects mortgagesaffects Ginnie Maes. Ginnie Maesbehave contrary to the best interest of theinvestors in all cases. As a homeowner,when Alan Greenspan announces theFederal Reserve's plan to lower interestrates, the first reaction is to refinance. Asa homeowner, you feel great when yourefinance. However, as an investor, wheninterest rates drop, capital flows out ofyour investing account and back to themortgage companies as the mortgagesget refinanced. Reinvestmentof that capital is going to be at lowerand lower rates of interest, which ultimatelymeans lower returns to investors.
When interest rates rise, just theopposite happens. Homeowners holdtheir mortgages and no one refinances.This actually lengthens the life of theGinnie Mae, making it effectively a morelong-term security. As such, with ratesrising, long-term securities fall muchharder and further in price than short-termsecurities. Just when you'd want toget your capital back and invest at higherinterest rates, it effectively stops comingback to you. If you sell then, there's achance you could get clobbered.
While Ginnie Maes offer what appearto be attractive government-guaranteedAAA rates of return, the dynamics ofthese securities operate contrary to thebest interest of the investor.
If you stick with traditional income producingbonds, with a face interestrate and date of maturity, you willalways know what you have, at leastwith respect to how and when your capitalis flowing back to you. Steering clearof mortgage-backed securities couldsave you a bundle. Don't get caught withyour interest rates down.
Jonathan Krasney is a financial
planner and the president of
Krasney Financial, LLC, in
Brookside, NJ. He is an expert
in personal finance issues for
high-net-worth individuals and
often assists clients in estate planning issues,
tax management, bonds, mutual funds, and
charitable giving. He has appeared on CNN,
CNNfn, and can be seen regularly on
CNBC's Power Lunch "Making Your Money
Work" segment. Mr. Krasney welcomes questions
or comments at 888-572-7639 or