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Many investors want exposure to real estate, but investing in a physical property like a house or commercial building requires a lot of upfront capital, often far more than the average person has sitting in cash. There are other ways to have real estate in your portfolio, though, such as real estate investment trusts (REITs), mutual funds or exchange-traded funds (ETFs) that specialize in real estate, or even mortgage-backed securities (MBS).
What are Mortgage-Backed Securities?
A mortgage-backed security is a financial instrument that is backed by a collection of mortgages that are essentially bundled together. The most common form is a pass-through, which means that mortgage payments made are then passed through to investors, giving the MBS owner a steady stream of income. There are also CMOs, collateral mortgage obligations, where the bundled mortgages are separated into “tranches” with different maturity dates and risk profiles, each of which is given its own credit rating.
If you were around during the financial crisis of 2008, you know that mortgage-backed securities played a big part. This was largely due to the fact that MBSs were unregulated, resulting in highly speculative securities full of low-quality loans. In particular, CMOs with tranches of very risky mortgages were given good credit ratings by agencies like Moody’s, leading many investors to think a very risky investment was in fact safe and predictable. The good news is that MBSs are now regulated, meaning they are far less risky than before.
Should You Invest?
There’s no one answer to the question, since it will depend on your personal financial situation and goals. Mortgage-backed securities are considered to be a fairly safe investment these days, and can offer more attractive yields than US government bonds, making them attractive to investors that want a predictable income stream or have a low tolerance for risk. However, they offer little in the way of price appreciation, so investors with a longer time horizon that want exposure to real estate would probably be much better served by investing in a REIT or real estate fund.
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