Revisiting the TSP F verses G fund

In a Federal News Report, Mike Causey quoted Arthur Stein, a D.C.-area financial planner who said it’s a fact, “The F fund gets no respect, but it should.”  The TSP F fund tracks the Barclays US Aggregate Bond Index.

While I agree that in the past the TSP F fund deserved more respect, I guess I will take the other side of the argument in today’s environment.  My main take-away is past performance does not matter when it comes to comparing the TSP G and F fund.  This holds true for most bond funds today.

Since the TSP F fund’s inception we have been in a declining interest rate environment. Declining interest rates allowed the TSP F fund and other bond funds to capture capital gains in addition to yields.  That 10-year annualized return of 5% quoted in the article includes 1) the higher yields from the past and 2) the capital gains from the decline in yields during the last 10 years.

Do you want to know what the annualized total return of the TSP F fund or the index will be over the next five years? Around 2.2% – its yield today.  If interest rates remain unchanged, you will simply receive the 2.2% yield for 5 years.  If interest rates rise to 4%, then the higher yield will be eaten into by the capital losses and you will still receive around a 2.2% annualized return if you hold the fund the entire 5 years.

For the TSP F fund to return 5% annualized over the next five years, interest rates would have to hold at 2% for four years and plunge well below zero in the fifth to capture capital gains of 17%. Of course, then you would have a negative yielding fund. Let’s hope that does not happen.

The TSP G fund will earn the same as the TSP F fund if interest rates remain unchanged, but it will outperform if interest rates rise because it incurs no capital losses as interest rates rise.

So, if the Federal Reserve meets their target by 2019 by raising rates 0.75% per year, then the TSP F fund (if it matches) would incur 3.75% capital losses each year- more than wiping out its low yield.

Arthur Stein should know better, but many financial planners simply do not because they sell financial products relying on others to analyze investments.  The professional managers of the TSP Lifecycle funds know better.

The Lifecycle Income fund for retirees only allocates 6% to the TSP F fund and 74% to the G fund.  I do not know what they were holding in these funds 5 years ago, but one could argue that even 6% is too high today for a buy & hold fund… at least until interest rates find their new (higher) normal rate.

If you want more reading on the subject, you can view my Compare TSP F and G Fund in my online allocation guide.  Or my older post at TSP G fund verses TSP F fund today.  My recent post The Smart Bird: Inflation, COLAs and the Economy discusses why higher inflation expectations should lead to higher interest rates.  Invest smart.

Categories: Perspectives