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Sunday, October 25, 2009

Bob Brinker's GNMA VFIIX Bond Fund Timing Advice & My Alternatives

Saturday (Oct 24, 2009) a caller named John from Parsippany, NJ asked Bob Brinker for his opinion on market timing bond funds. John wanted to sell his bond fund and put the proceeds into low yielding money market funds.

Brinker defended his advice to stay in GNMA funds. Brinker said the net asset value (NAV) of his favorite GNMA fund from Vanguard, VFIIX, would have to fall to $10.40 in a year to lose the approximately 3.3% yield from the fund to break-even with money market funds.

VFIIX PRICES
DateClose
23-Oct-0910.74
22-Oct-0910.75
21-Oct-0910.74
20-Oct-0910.76

Perhaps John should read my article "Bob Brinker GNMA Advice - I Like CDs Better" where I wrote:
Bob Brinker has taken a lot of calls from his listeners worried about inflation leading to net asset value (NAV) losses for his favorite GNMA fund (VFIIX at Vanguard) when rates soar after inflation returns to a normal level.

Bob's standard answer is you should be willing to accept NAV fluctuation for VFIIX between $9.50 and $10.50.

I think the callers have a valid concern and I am not happy with Brinker's answer.

Today VFIIX closed at $10.71 so a decline in NAV to $9.50 would be an 11.5% loss!

Why take a risk of a 12% loss to get an extra percent or two of interest if you don't have to?
Just because you can put the proceeds from selling VFIIX into the money market fund from Vanguard currently paying only 0.17% doesn't mean that is what you should do!! There are funds that pay better rates. Also, rates on money funds will go up if interest rates rise so the difference Brinker calculated is ONLY good if rates stay the same.

For example, when I sold the GNMA fund in my taxable personal account, I put the money into a CD at HSBC. Rates are down, but you can still get a 1-YR CD at HSBC paying 1.85%. I also have a significant amount of cash at HSBC in their online savings account earning 1.35%.
Due to FDIC and NCUA limit concerns, I have CDs and savings accounts at several institutions.

I have at Star One Credit Union earning 1.50% in their savings account linked to a checking account that pays 0.50%. Both accounts have NCUA insurance for $250,000 (FDIC equivalent for credit unions.)
Finally, Bob Brinker spends a good portion of his show bashing the Obama administration and congress for deficit spending. High deficits will lead to higher interest rates for one of two reasons.
  1. The fed will have to continue printing money causing inflation
    or
  2. Making the interest payment from all this debt will require more debt.
Treasury investors could see either case as a death spiral similar to what happened to GM and other companies that went bankrupt. They may demand much higher interest to compensate

Why does Brinker keep saying he sees VFIIX limited to $9.50 to $10.50? Does he not have a long-term chart for VFIIX?

Continued fiscal incompetence in Washington COULD cause interest rates to soar to the levels seen in the 1970s and 1980s. If that happens, do you really think the NAV of VFIIX will "only" drop 13% to Brinker lower limit of $9.50? Here is a historical chart to help you answer that question.


Consider TIPS (Chart and Info)

You are not limited to FDIC/NCUA savings accounts and CDs. The US Treasury will auction TIPS tomorrow (CUSIP Number 912828KM1) that mature in 4.5 years. The "base rate" for those is expected to be about 1% plus the principal will be adjusted for inflation. If we get 2% inflation in the next year, then you should get a return of roughly 3.0%. If we were to get 10% inflation in one of those years, then the return for that year should be about 11%. I've used money in IRAs to buy TIPS funds and will buy CUSIP Number 912828KM1 tomorrow via my broker for my 401(k) rollover and for my ROTH.

If you don't have a large amount to invest, then you could buy iBonds. I expect the base rate for iBonds will be zero next month but the inflation adjustment should be 3.0%. Thus, you can buy $5,000 worth of iBonds on Nov. 1 and probably get about 3.0% for the next six months. I-Bonds also give you inflation protection PLUS tax deferral you don't get with TIPS.

See I Bonds Explained

In summary, Brinker built a "straw man" argument why he prefers Vanguard's GNMA over their money market fund. Who says you should leave your money in a low yielding money fund when there are far better alternatives that will benefit if rates go up? This article suggested CDs, savings accounts paying up 1.5%, TIPS and iBonds as better choices.

More info:

Nov. 2, 2009 Update: The Bureau of the Public Debt today announced an earnings rate of 3.36% for Series I Savings Bonds issued from October 2, 2009 through April 30, 2010. The base rate for these iBonds will be 0.30% and the inflation component is 3.06%. See:

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10 comments:

  1. your gnmas were in a taxable account, what does one do when they are in ira roll over with vanguard?

    ReplyDelete
  2. Anonymous wrote: "your gnmas were in a taxable account, what does one do when they are in ira roll over with vanguard?"

    Actually, I owned Vanguard's GNMA in a taxable account and a 401(K) roll-over. I also recommended it as part of my newsletter's "explore portfolio" (subscribe) before I sold it. Last month I gave specific advice to my newsletter subscribers that I was buying the 5-YR tips at last Monday's auction for the explore portfolio PLUS my ROTH and 401(K) roll-over. I was very happy with the results as the base rate is far above what iBonds will pay. Unfortunately for others but not a surprise, the next TIPS auction isn't until next year.

    Have you read my article "I-Bond Rates: November 2, 2009 through April 30, 2010" where I explain Series-I bonds are now paying 3.36%? You can buy $10,000 of them this year and another $10,000 in January and get very good rates with 100% US Treasury backing PLUS inflation protection PLUS tax deferral of income. I usually don't give specific advice outside my newsletter, but that is not a bad deal if you want to defer some income while in the asset accumulation phase.

    ReplyDelete
  3. Interesting: I kind of feel that my Vanguard Admiral shares VFIIX is in a Madoff fund (to good to be true) having watched my equities go through the wringer and the VFIIX just keep pulling like a freight train. Ive had the fund since the late 80s and it's size is significant and I am addicted to the compounded returns.
    I'd like to ask as I watch the fund like a hawk, do you think it will drop like a brick or like a feather when it finally gets bit by inflation?

    ReplyDelete
  4. 1% base rate for tips is not that good. tips are best held in a tax advantaged account.

    ibond base rate is dreadful at 30 basis points. ibonds are best held in a taxable account. also you'd lose 3 months of interest if held less than 5 years.

    what happens if the government starts to lie about inflation, these inflation protected securities will really do poorly. i don't like either at this point and would consider the tips fund in an ira rollover.

    i 100% agree with kirk about losing nav appreciation in gnmas. at these lofty nav levels there seems to be one way the nav will go and it is not up. cds seem to pay so little, 1.5% to 2%. how does one factor the drop in gnma nav as the yield increases up vs a cd with a fixed rate? this is something i don't understand how to calculate. if gnma nav were to drop 40 cents from $10.78 to 10.38 that is a 3.7% drop in the value of the account but yield would go up but no one knows by what amount. how does one decide if the gnma loss of nav for the increased yield is better than accepting a cd yield that is 1/2 the gnma yield?

    ReplyDelete
  5. Can you "anonymous" posters get an account or sign your name if you want questions answered? Or sign you name and city at the end of the question such as "Pete from Pittsburgh" or Mark from Maui."

    I'd like to ask as I watch the fund like a hawk, do you think it will drop like a brick or like a feather when it finally gets bit by inflation?

    To answer one has to know how much inflation and how quickly it hits.

    As I showed in the article Inflation Protected Series I Bonds Now Pay 3.36% CPI-U inflation will jump from negative 1.3% to positive 2.7% in December even if CPI is flat between the last reading and the December reading.

    Do you think bond investors will want a better return when they learn inflation in December will be 4% higher than the last reading even if everything stays the same?

    ReplyDelete
  6. i don't see how to create an account, this is tjg911, tom gallucci.

    as i stated my gnmas (admiral shares) are in a rollover ira. i hate to lose the nav appreciation, as i said nav has nowhere to go but down and like you said kirk, why lose that? i looked at other vanguard bond funds (short term) and their duration is about the same as the gnma fund so they don't look like a good alternative for gnma since they'll see their nav drop about the same as rates rise.

    if i exchanged my gnma fund into the prime money market and then buy vanguard cds in my ira, i don't know how to figure if a cd with a 1.8% or 2% yield is a wise choice since gnma is currently at 3.3%. i could capture the nav appreciation this way but the yield is about 1/2 of the gnma fund and as the nav drops the yield on gnma will be increasing which just adds to the complexity.

    how does one decide what cd yield makes sense to lock in the gnma nav appreciation figuring the gnma yield will be rising? is there a website with a calculator as there is for so many other things?

    tom

    ReplyDelete
  7. Ton tjg911 wrote: how does one decide what cd yield makes sense to lock in the gnma nav appreciation figuring the gnma yield will be rising? is there a website with a calculator as there is for so many other things?

    Tom, I heard there is a device called a "crystal ball" that will give you an exact answer that will never be wrong. For those of us without access to one, we weigh the risks and rewards as I have outlined and make a decision based on our own risk tolerance. Some bears I've read believe the US economy is in for another decade of deflation no matter how much money the government prints so they recommend Treasuries and GNMAs.

    To do the math, I write spreadsheets. Maybe you can hire a CPA to do it for you on an hourly basis?

    ReplyDelete
  8. Does it make sense to buy the TIPS mutual funds, or etf, if there is one.

    If an etf is ok, maybe you can suggest one.

    R Schmidt Chicago

    ReplyDelete
  9. To R Schmidt Chicago

    The TIPS fund we recommend in "The Retirement Advisor" (See Kirk's Two Investment Letters) is up 13.15% YTD through today. I suspect the ETF we recommend as an alternative is up a similar amount, but I don't have the current data. These are up quite a bit since I made the recommendation to sell GNMAs and buy TIPS.

    I only give recommendations in the context of an overall portfolio in my two newsletters but I'd say individual TIPS and TIPS funds have been very good to me.

    The TIPS funds are up over 16% in the past year and setting new highs so they too could see some decline in NAV if rates go up without a surge in inflation. Given TIPS funds are up much more than GNMA fundss, we can afford to give back more to be "even."

    ReplyDelete
  10. In the article I wrote: "I've used money in IRAs to buy TIPS funds and will buy CUSIP Number 912828KM1 tomorrow via my broker for my 401(k) rollover and for my ROTH."

    I made that buy with personal money AND I bought that TIPS auction for my newsletter explore portfolio. As of last night, CUSIP Number 912828KM1 was up 1.9% since buying!!!

    VFIIX fell 2¢ in NAV over the same period....

    ReplyDelete

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