Invest Your Money on Other People’s Mortgages
Far more complicated even than floaters are the mortgage-backed securities issued by federal agencies such as Ginnie Mae and by some government-sponsored enterprises, such as Fannie Mae and Freddie Mac.
Mortgage-backed securities— the vast majority of which are issued by agencies — are very different than most other bonds. They do not offer as consistent and predictable a stream of interest income as do most bonds.
Bathe in the mortgage pool
When you purchase a mortgage-backed security from, say, Ginnie Mae (minimum investment $25,000), your money goes into a pool of mortgages. Whereas most bonds pay you a set rate of interest, usually twice a year, mortgage-backed securities pay you a certain rate of interest plus the steady or not-so-steady return of your principal. (You don’t get a big lump sum when the bond matures.)
Most mortgage-backed securities issue monthly payments. The amount of principal you get back on a monthly basis is determined largely by the rate at which mortgage-holders pay off their debt.
If interest rates drop and thousands of the mortgage holders decide suddenly to prepay their existing mortgages (in order to refinance), you may get back your principal much faster than you had anticipated. In a sense, a mortgage-backed security has the same back-at-ya risk as a callable bond.
Decide whether to invest in the housing market
You don’t need to invest the $25,000 minimum required by Ginnie Mae to invest in mortgage-back securities. You can get a Freddie Mac for as little as $1,000. But should you?
David Lambert, a financial planning professional who is the founding partner of Artisan Wealth Management, based in Lebanon, New Jersey, doesn’t think so. Lambert was formerly the head trader at the agency-bond desk for a major Wall Street firm.
This guy knows a lot about agency bonds. If I were a retail investor, unless I had a really huge amount of money and felt that I really knew what I was doing, I wouldn’t invest directly in mortgage-backed securities, Lambert says. The complexity of them makes them inappropriate for the average investor.
Instead, says Lambert, if you want to invest in mortgage-backed securities, do so by investing in, say, a good mortgage-backed security fund. There are plenty of good ones out there — both mutual funds and exchange-traded funds. I’d look to a solid company like Vanguard, Fidelity, iShares or PIMCO, he says.