Financial Q&A: A banks failure may not lead to individual losses

Submit your question to Steve Dinnen at: money@csmonitor.com

Q: I have a $25,000 CD, maturing in March 2009, through IndyMac bank. Now that it has failed, what do I do? On another topic, what is the difference between a money-market fund protected by SIPC and one protected by FDIC?

S.N., Portland, Ore.

A: You shouldn't have to do anything, says Morris Armstrong, a financial planner in Danbury, Conn. You should receive principal plus interest as stated when the CD matures. The Federal Deposit Insurance Corp. (FDIC), a government agency, insures bank deposits against the sort of calamity you have experienced at IndyMac. It was taken over by bank regulators July 12. Deposits up to $100,000 are insured. The Securities Investor Protection Corp. (SIPC) is a private insurance program meant to protect you in the event that a brokerage holding your money-market account goes under. Mr. Armstrong says that it does not protect against loss of principal in the money-market fund.

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Q: I'm 70 years old and in need of monthly income from my investments. What are the pros and cons of investing in a GNMA fund?

B.G., Pittsburgh

A: A GNMA is a bond made of a basket of residential mortgages from across the US. Adam Bold, founder of The Mutual Fund Store (mutualfundstore.com), says that their risks and rewards come from changes in interest rates because GNMAs are some of the longest-term securities available. When interest rates fall, the value of existing bonds rise.

Interest rates fell dramatically the last couple of years, and GNMAs performed well. People who took out 30-year mortgages at high interest rates refinanced as rates fell, turning their original mortgages into much shorter-term securities than originally expected. Holders of GNMAs got the yield of a long-term security with the volatility that characterizes short-term securities.

The opposite situation might exist now, says Mr. Bold. Interest rates are more likely to go up, and bond prices fall when interest rates rise. At higher interest rates, few people refinance mortgages. GNMA holders can find themselves stuck in long-term securities paying relatively low interest for a long time. They get the yield of a short-term security and the volatility of a long-term security.

An additional risk associated with GNMAs is that people overvalue the US government's guarantee of the securities. The full value of the guarantee is only realized when the bonds mature, typically in 30 years. This means you would be 100 before the guarantee fully kicks in. And the guarantee does not mean that the bonds' value will not fall in the meantime, resulting in a loss if you sell the bonds before maturity.

If you want to invest in GNMAs, you should do so through mutual funds, not individual bonds, because of the diversification and professional management funds offer, Bold says. As new money flows into a fund, the fund can buy new bonds at current interest rates. A portfolio of bonds of different maturities and paying different interest rates is diversified against the risk of any particular shift in interest rates.

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