GSE bonds can boost cash flow |
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As you can see, this bond is callable September 2008 at 100. That means, if the bond is called, you'll receive
$1,000 per bond, not the $1,006.60 you paid. You paid a premium because the bond's coupon, 5.33 percent, is higher than what the
benchmark investment, a Treasury bond, is paying. The coupon is the stated interest rate that's set when the bond is issued. While
the risk of default may be very slight, the fact that the bond can be called means you're taking on reinvestment risk. The bond
would likely be called if rates drop, and that means you could have a hard time finding another investment with a high return and
as little risk.
"Yield to worst" is your return if you buy the bond now and it's called at its next opportunity to be called, which
is September 2008. "Yield to maturity" is your return if it's not called and you're able to hold the bond until the maturity date of
September 2009. The main reason for the difference between yield to maturity and the coupon is the premium.
Jason Flurry, Certified Financial Planner and principal at Legacy Partners Financial Group in Woodstock, Ga., says
these bonds can present a good opportunity.
"You can achieve a very attractive cash-flow rate for anywhere from a few months to a few years in the 5 percent to
6 percent range. Obviously, that's a premium rate of return so you're going to have to pay a premium price to get it, but the cost
to buy these bonds is next to nothing. The reason it makes sense to look at these versus other options that are out there is because
of the mortgage crisis and because they're out of call protection. You don't have much certainty that they're going to be hanging
around until maturity."
While Flurry favors secondary-market bonds in this particular set of circumstances, another financial planner advises
most individual investors to stick with new issues.
"I'm not saying you shouldn't buy (on the secondary market), but you have to know
what you're doing," says Herb Hopwood, CFP and principal at Hopwood Financial Services in Great Falls, Va.
"If you're buying a new issue, you're buying at par. Worst-case scenario is it gets called in three to six months if
you screwed up and bought one that was that short. But you're going to get your money back and you got that decent interest rate all
along," he says. "If you bought something at par and a half, and it got called in three months, you could have something that looked
like it was 5.5 percent and it becomes 3 percent real quickly. Always price these things off 'yield to worst'; assume it will get called
at the first call date at par."
Figure worst-case scenario
Flurry agrees that yield-to-worst is an important number. He notes
that investors need to shop around and compare yield-to-worst against
current CD rates, for instance. In our example, the yield-to-worst
is very low and that may be a reason to avoid it. If it had a similar
coupon but a "yield to worst" in the 2.5 percent to 3 percent range,
it may be worthwhile if the premium isn't too steep. Ideally, your
worst situation should be better than what you could get on the
open market.
Flurry says this is for the person who wants some extra money to help with expenses, or for saving.
"If yield is a
consideration and safety is a No. 1 concern, this is an alternative way to generate yield and cash flow. Instead of getting a CD
for 3 percent down at the bank, they could get the same yield or better but the actual interest that comes in would be more in the 6
percent range."
You can buy new or secondary issues of GSEs through institutions such as Fidelity, Vanguard and Schwab. Most have
fairly extensive tutorials or will also assist you by phone. If you'd be more comfortable having a financial adviser handling these
investments for you, try Bankrate's directory of Certified Financial Planners.
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