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Be careful where you look for yield

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"U.S. Government, whether it's Treasuries, TIPS or U.S Agency; Schwab zero percent, Goldman Sachs 9.42 percent. Mortgage pass-through are Ginnie Maes. They're liquid, they trade a lot and they're very safe -- backed by the U.S. government. But mortgage CMOs is where it really stands out. That's collateralized mortgage obligation, a structured product. These structured products are not as liquid, and then you compound it by the risk level. The ratings agencies and the creators of these products never (wondered) what happens if we have the 100-year flood."

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Bonds versus bond funds
To be sure, you should never think of bond funds as an alternative to money market funds no matter how they're marketed. The share price varies from day to day and there's no maturity date as there is with an individual bond. If you need to raise cash when the share price is down, you will lose principal.

Hopwood advises consumers to stick with individual bonds rather than bond funds. "Mutual funds are wonderful for certain products, but it's a giant democracy. You're thrown in there with everybody else. If somebody decides to get out, you're left with the remaining portion and you can't time that. They can say that (the fund) will come back in time, but what if you don't have the time? The structure doesn't work well in many of the bond products."

Crane says this episode should serve as a cautionary tale regarding hot products. "A lot of ultra-short bond funds were created for the wrong reasons when investors were screaming for yield in 2003 and 2004 when the federal funds rate was at 1 percent. It's unfortunate for the investors, but it's fortunate that the lesson is upon us when the cause has returned as well. Now that we have ultra-low rates again, maybe this time, investors won't reach for yield since they have the carnage now staring them in the face."

Money market funds, a few of which have had their own brushes with subprime junk, may be the investment du jour despite declining yields, as they offer significantly more protection from the carnage. The Investment Company Institute reports that retail investors have pumped up money market funds by nearly $40 billion in the past six weeks.

Bankrate.com's corrections policy -- Posted: April 9, 2008
 
 
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