What type of bonds should you hold inside a tax-deferred retirement plan?
Instead of Treasuries or corporates, consider mortgage-backed securities such as Ginnie Maes, issued by the Government National Mortgage Association (GNMA). Such securities, which entitle investors to mortgage payments from home buyers, offer high yields (now around 8%) and excellent credit quality.
Nevertheless, there may be practical problems. Investors receive principal and interest each month (you’re on the flip side of mortgage payments) but many people think it’s all income. Thus, you might inadvertently spend returned principal.
Moreover, the greatest risk to investors in mortgage-backed securities is that interest rates will fall, mortgages will be prepaid, and investors will get their money back, to be reinvested at lower yields.
Today, with mortgage-rates near two-year lows, refinancing may not be a major threat. If you’re interested in these securities, invest through a mutual fund, where all distributions can be reinvested in additional mortgage-backed securities.
