Question from Randy: Is there any reason why my complete bond portion of my portfolio cannot be in the Vanguard GNMA fund (VFIIX)? It has a nice yield and is near its lowest price, and its holdings are backed by the full faith and credit of the U.S. government.Thank you very much.
As I discuss in my book, The Only Guide to a Winning Bond Strategy You’ll Ever Need, I don’t recommend any MBS (mortgage back securities). While the GNMA fund is low cost and has no credit risk you have no certainty of maturity. You get a small risk premium for taking the uncertainty of maturity risk and then you accept an I lose-I lose game. You lose if interest rates fall as homeowners refinance and then you get paid back sooner than expected and have to reinvest at lower rates and you lose if rates rise and you get stuck with a low interest rates for longer than you expected. And in both cases those risks can show up when your stocks are getting hit at the same time.
To me the preferred instrument by far, as recommended in the academic literature, is TIPS. Thus I would recommend you place your money in the Vanguard TIPS fund, or save the expense and just buy individual TIPS, perhaps a ladder. And right now yields are well above historical average levels. Currently I have about 85% of my tax deferred fixed income investments in TIPS and will go to 100% if real yields rise further. You have no credit risk and no inflation risk and you have a guaranteed real return now of close to 3%, tough to beat.
Disclaimer: Mr. Swedroe’s opinions and comments expressed are his own, and may not accurately reflect those of the firm, nor Moolanomy and its owner.