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Up 30% with GNMA

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You’re right to be concerned about higher interest rates and a decline in bond prices. Yet it would be a shame to miss the boat on the wonderful returns coming from bond funds with short-term maturities. The Vanguard GNMA fund, for example, with an average maturity of less than two years, has returned 7.6% YTD. 

For income investors, GNMA provides a relatively attractive yield of 3.27% compared to other short-term bonds like Treasuries. The Vanguard Short-Term Treasury, for example, yields only 0.30%. And compared to stocks, the Vanguard GNMA fund was up 7.2% in 2008 while the S&P 500 lost 38.6%. That’s an outperformance of 45.8%. Look how smooth the ride has been in GNMA.

 

What would your portfolio have looked like with a balanced approach? You can run some back-of-the-napkin scenarios by putting a percentage of your portfolio equal to your age in GNMA. This helps you see how including GNMA in your portfolio could lessen the blow when stocks are down. For example, a 65-year-old who put 65% in GNMA and 35% in the S&P 500 would have lost only 8.83% in 2008—and by staying with that mix would already be above 2008 levels today. That has a nice ring to it, don’t you think? 

GNMA was up 7.0% in 2007, 7.2% in 2008, and 5.3% in 2009. And for illustrative purposes, let’s assume the year ended with GNMA up 7.6%. If you compound 7%, 7.2%, 5.3%, and 7.6% over four years, that’s an increase of 30%. Don’t make the mistake that many investors do of looking at past performance and just adding up 7%, 7.2%, 5.3%, and 7.6% to get 27%. You’re leaving out interest on interest. In this example, compound interest pays an extra 3% to get you 30%. In the case of GNMA, that’s about a year’s worth of interest for nothing.

 

If interest rates should go up over the next four years, GNMA’s short-term maturity will help protect you from the declines in bond prices. Its duration, which measures a bond’s sensitivity to interest rates, is only 1.9 years. This means that for every 1% increase in interest rates, the price of GNMA will fall by approximately 1.9%. That’s not unbearable, and the interest payments you receive will help soften the blow as you wait for the fund to invest in higher-yielding bonds. I consider that a price worth the wait.

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E.J. Smith

Editor-in-Chief
E.J. Smith is Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH. His first drum set was a 5-piece Slingerland with Zilldjians. He grew-up worshiping Neil Peart of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West and Paris. Please get in touch with E.J. at ejsmith@youngresearch.com.