WHAT CAN YOU EXPECT TO EARN FROM AGENCY BONDS?

Investors who purchase U.S. Government agency bonds often point out that, over time, they tend to perform somewhat better than Treasury securities. Yet when fewer U.S. treasuries are issued, government agency bonds also can fill the need for these types of investments.

Contrarians will argue that the volatility of government agency bonds makes them a poorer investment than, say, blue-chip stocks. This volatility stems from the possibility that a number of home owners represented in the pool might decide to prepay their mortgages for any number of reasons: They may sell their home, refinance it if mortgage interests rates fall, or simply decide to pay down the principal.

When a number of mortgages in the pool are paid before maturity, the investor receives payments of interest and principal sooner than planned. This can be a problem if the investor had counted on a certain fixed rate of return, and if the investment matures early at a time when interest rates on similar investments are low.

Yet many investors continue to purchase Ginnie Maes, Fannie Maes, and Freddie Macs, attracted by their respectable long-term performance and low risk of default.

Just as important to some investors as return is the issue of safety. And that is the topic of the next section.