From Eric: Michael - appreciate the rundown on the G Fund. Would you please share a similar discussion on the F Fund? Thanks!
Hello Eric,
Let's consider why the TSP Lifecycle Income fund for retirees holds 74% G fund and only 6% in the F fund - and less in the other L funds.
The F fund invests in real securities with an average duration of around five to seven years. I say real because the G fund does not invest actual securities - there is no actual buying and selling. The G fund's interest rate is just a formula based on long term government bonds similar to what the imaginary social security trust fund earns. The G fund carries no risk of capital losses when interest rates rise and no default risk.
Since the F fund holds actual securities, its holdings incur capital losses when interest rates on similar duration fixed income securities rise and capital gains when interest rates decline. Probably the biggest difference historically in the two funds' performance has been that the TSP F fund has benefited *since inception* from the long term declining interest rates for securities of all bonds.
We are reaching the end of this trend soon and are now since we are bouncing off of the lowest interest rates ever in history. This is why past performance does not matter when comparing these two funds. (Negative interest rates would extend the trend a little longer, but then the entire system will breakdown.)
For market timers the only time the TSP F fund outperforms the G fund by anything worth measuring is when interest rates are moving down (to capture the capital gains). But you need to miss the time frames when interest rates are rising (to avoid capital losses). These capital losses are not devastating like riding a bear market in stocks. The simple formula is for every 1% move in interest rates, the capital gains/losses are 5% in the opposite direction. A 1/4 percent decline in interest rates will provide an additional 1.25% capital gain to the F fund.
Currently the TSP F fund yield is getting sandwiched between short term rates being pushed up by the Fed and the rapidly declining long term rates that are coming down due to the flight to safety in US bonds - away from negative interest rates abroad and declining stock markets.
I recommend to my subscribers who are long term investors (defined simply as those who do not want to make a lot of IFT) to stick to the TSP G fund when out of equities since its interest rate will remain close to the TSP F fund yield. You will miss out on the volatility of the F fund and its higher risk. The magnitude of gains or losses in the equity funds overshadows the difference in these two fund's returns ...so invest your efforts in getting the equity fund timing right.
The TSP Lifecycle fund managers also get this and this is why they only make a token investment in the TSP F fund. Other *non* TSP Lifecycle funds do not have the luxury of investing in the TSP G fund and are forced to take on the risk of real-world bonds to obtain any yield today. It will only get worse for them with negative interest rates.
This is why I do *not* recommend transferring your funds out of TSP when you retire. When retired you should hold a low risk portfolio and not be chasing high risk returns in the stock market. Not to mention that management fees and commissions will eat up your meager retirement income in today's low yield world.
Sorry for going beyond the question, but I've seen little information out there on some of these points. Commission based money managers will never talk about the last points since they can not make money unless you transfer out of TSP.
Michael Bond
TSPsmart.com
Posted by: michaelhbond@yahoo.com
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