A popular bond category since the 1980s, mortgage-backed securities (MBS) can be a highly profitable, extremely complicated, and highly risky investment option. The key word here, though, is complicated, and the intricacies of some of these securities (particularly the CMO, or collateralized mortgage obligation, variety) make them inappropriate for novice investors. In fact, they were largely implicated in the big financial meltdown of 2008. But the most basic form of these bonds, the MBS, can make a good addition to an income-focused portfolio.

Financial institutions help create mortgage-backed securities by selling part of their residential mortgage portfolios to investors. Investors basically buy a piece of a pool of mortgages. An investor in a mortgage-backed security sees profit from the cash flow (people's mortgage payments) generated from the pool of residential mortgages. As mortgage payments come in, interest and principal payments are made to the investors.

There are several types of mortgage-related securities available today, and one of the most common is the pass-through Ginnie Mae, issued by the Government National Mortgage Association (GNMA), an agency of the federal government. GNMA guarantees that investors will receive timely interest and principal payments. Investors receive potentially high interest payments, consisting of both principal and interest. The rate of principal repayment varies with current interest rates.