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Updated Saturday, November 10, 2012 at 10:01 PM

Scott Burns: Watch out for interest-income fall in GNMA fund

By Scott Burns
Syndicated columnist

Investing

Q: My wife and I are both in our 70s. We have a considerable amount of money invested in the Vanguard GNMA mutual fund. How will the latest move by the Federal Reserve to purchase mortgage bonds affect this fund? I have a feeling this does not bode well for us.

A: Let’s look at how large the Federal Reserve’s promised monthly $40 billion purchase is. The Vanguard GNMA (ticker: VFIIX) fund is the largestof those that specialize in securitized, government-backed mortgages.

But the Fed’s mortgage purchases — to stimulate the economy by suppressing interest rates — will be done at a rate sufficient to absorb the entire Vanguard GNMA fund in the first month. It would take only a few more months to absorb the entire mutual-fund sector that specializes in GNMA securities.

The entire GNMA market, however, is much larger — about $7 trillion. Even so, these monthly purchases will have a profound effect on the market. Will it be good or bad for you as a shareholder? That depends.

If you buy a conventional bond fund, the value of the bonds will decline when interest rates rise, and rise when interest rates fall. That’s because the value of the fixed-interest rate coupon on a bond remains the same, so new investors will pay more or less for it depending on whether rates rose or fell.

But it’s different with a mortgage-backed security.

When interest rates decline, people with mortgages refinance to lower their rates, depriving the mortgage owner of an increase in value. When interest rates rise, they hold on to their mortgages longer than they otherwise might. This locks the mortgage investor into a below-market yield and causes values to decline somewhat.

As a result, the cash yield on GNMA funds has run a bit higher than the yield on comparable conventional bond funds.

Will you lose money or face some disaster? Probably not. What you should prepare for is a continuing decline in interest income from the fund.

Q: I am probably not going to earn enough credits to qualify for Social Security. Does this mean I won’t qualify for Medicare as well?

A: Those who don’t qualify with enough work credits through the regular Social Security program can qualify for Supplemental Security Income (SSI) benefits. This program guarantees that everyone has some level of disability or retirement income, even without having worked long enough to qualify for Social Security.

If you qualify for SSI benefits, you qualify for Medicaid, and you will also be eligible for food stamps.

This year the basic monthly SSI payment is $698 for an individual and $1,048 for a couple. This compares with an average monthly benefit of $1,130.94 for individuals who receive Social Security retirement benefits. The basic SSI benefit is often supplemented with additional funds that vary from state to state.

Questions: scott@scottburns.com

Copyright, 2012, Universal Press Syndicate






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