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Are government-backed agencies safe investments?

Benefits of Government-backed Investments

You've worked hard, avoided flash sale sites and squirreled away a nest egg. It's time to put your money to work. Unfortunately, the idea of buying volatile stocks makes you break out in hives, which leads you to believe safe investments suit your financial style.

Fortunately, investing in government-backed agency or GSE bonds is typically a sure thing. Not only will your initial funds be returned when the bond matures, but you'll also be paid interest over the life of the bond. You'll need to be prepared to part ways with your money for months or years, though. Short-term bonds can take up to five years to mature; long-term bonds may require more than 20 years to mature. In general, the longer it takes a bond to ripen, the more money your investment will make over time. If you decide to cash in your bond before it matures, you could make or lose money depending on prevailing interest rates [source: Kansas].

The downside? While government-backed agency and GSE bonds are ideal for securing your funds, they won't make you rich. The safest assets usually yield the lowest returns. This is because they don't pose much of a risk; the better their credit rating, the lower the interest rate on your investment [source: Marquit, PIMCO]. In February 2013, for example, the interest rates on GSEs were hovering around 3 percent [source: Edward Jones].

Fortunately, understanding some of the tax benefits may assuage any regrets you harbor for failing to seek greater rewards in risky markets. Interest income from some GSE bonds, like those issued by Federal Farm Credit Banks Funding Corp., is exempt from state and local tax. Discovering whether your investment gains are tax-free requires some research; interest income from Fannie Mae, for example, is not state or local exempt. Keep in mind, too, that if you sell a bond before it matures, the profit will be subject to federal and state capital gains tax [source:Fidelity].