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

Date	Close
23-Oct-09	10.74
22-Oct-09	10.75
21-Oct-09	10.74
20-Oct-09	10.76

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%.

• HSBC Savings & CD Rates

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.)

• Star One CU Savings and CD Rates
  

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.

Click for Current VFIIX Historical Chart

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:

• Bonds: Information About Investing in Bonds
  
  
• CD Rates at Largest US Banks
  
  
• Very Best CD Rate Survey

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:

• New Rates for I-Bonds

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Expected Inflation TIPS Spread Calculation

Bob Brinker often talks about expected inflation on his radio show Moneytalk. This article explains how to do the calculation.

From Calculating Expected Inflation using the TIPS Spread

Expected Inflation or TIPS Spread is the difference between nominal US Treasury bond rates and rates on US Treasury Inflation-Protected Securities. This spread is an indicator of expected inflation. The current rates are listed in table at the end of this article.

• Using 10 year rates, expected inflation is 1.99%
• Using 30 year rates, expected inflation is 2.21%
• US Treasury Rates at a Glance

This graph shows expected inflation vs. the growth rate of ECRI’s FIG going back to 2004.

Click for Full Size Image

ECRI FIG: The Economic Cycle Research Institute, ECRI, monitors over 100 cyclical indexes for major economies and uses the data in effort to make economic forecasts. ECRI's U.S. Future Inflation Gauge, US-FIG,is designed to anticipate cyclical swings in the rate of inflation. On Oct. 2, ECRI’s US-FIG rose again from its March 2009 51-year low to an 11-month high. ECRI's managing director, Lakshman Achuthan, said "the upturns in the US-FIG and its components have become fairly pronounced, pervasive and persistent. Thus, while this is not yet a significant policy concern, U.S. inflation is on the cusp of a cyclical upswing.”

Supply and demand issues can distort the TIPS Spread so buyers need to beware. For example, the Federal Reserve has been busy buying US Treasuries to help banks. The TIPS spread could widen when the Fed stops buying treasuries or goes into tightening mode.

• More about ECRI
• US Treasury Rates at a Glance
  
• Libor Rates at at Glance

U.S. Treasury Rates - 10/15/09

	COUPON	MATURITY DATE	CURRENT YIELD %
3-Month	0.000	01/14/2010	0.06
6-Month	0.000	04/15/2010	0.15
12-Month	0.000	09/23/2010	0.32
2-Year	1.000	09/30/2011	0 .95
3-Year	1.375	10/15/2012	1.49
5-Year	2.375	09/30/2014	2.35
7-Year	3.000	09/30/2016	2.99
10-Year	3.625	08/15/2019	3.41
30-Year	4.500	08/15/2039	4.24
TIPS - 10/15/09
	COUPON	MATURITY DATE	CURRENT YIELD%
5-Year	1.250	04/15/2014	0 .71
10-Year	1.875	07/15/2019	1.42
20-Year	2.500	01/15/2029	2.00
30-Year	3.375	04/15/2032	2.03

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Must Read: Beware of Annuities