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.
Answer From Larry Swedroe
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.
Best wishes
Larry Swedroe
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.
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Larry Swedroe is a principal and director of research at Buckingham Asset Management, LLC, an SEC Registered Investment Advisor firm in St. Louis, Missouri. He is also principal of BAM Advisor Services, LLC, a service provider to investment advisors across the country, most of whom are affiliated with CPA firms. However, his opinions and comments expressed within this column are his own, and may not accurately reflect those of Buckingham Asset Management or BAM Advisor Services.
Before joining Buckingham in 1996, Larry served as senior vice president and regional treasurer at Citicorp and vice chairman of Prudential Home Mortgage. Larry is author of The Only Guide to a Winning Investment Strategy You’ll Ever Need (updated and re-released in 2005), as well as six other books. Most recently, he authored The Only Guide to Alternative Investments You’ll Ever Need (2008).
Larry has started his own blog called Wise Investing at CBS Money Watch. Please check it out!
Thanks for the advice about intermediate bonds, I had a similar question which has been answered by this
Larry, can you explain to me what “insured” means in regards to bond funds, in particular FRCIX. I’ve called my broker and at best get an ambiguous answer. I doubt anyone there knows. My husband and I are in our 60’s and have half of our savings invested in this fund. It gave a reasonable tax free return with minimum risk. Or so I thought. We are quite worried. The fund is currently at 11.21 and we bought in at 12.69. The math is ugly.
@Joyce — I sent your question to Larry and I will be publishing the answer in a few days.
How will TIPS fare with the recent and massive increases in the money supply (i.e. inflation)?
Also, the CPI doesn’t match my or others real experience, living costs seem much higher than what the CPI tells us. Do TIPS really keep up with real inflation?