Would Cutting the G Fund Interest Rate Benefit Federal Employees?

By on July 19, 2015 in Retirement with 155 Comments

Image of cartoon person climbing a stack of money

For many current and future federal retirees, the Thrift Savings Plan (TSP) constitutes a significant portion of a person’s income during what could be a retirement lasting several decades. In your retirement planning, one important consideration is whether the money in your TSP fund will last as long as you need this money to pay your expenses.

The G fund is the most popular fund among the funds available in the Thrift Savings Plan (TSP). About 34% of TSP assets are invested in the G fund. The second most popular fund is the C fund with 28% of the assets.

It isn’t hard to see why the G fund is the most popular. It is the “safest” fund among the TSP funds that are available and no one wants to lose money. The G fund has never had a year in which it lost money so the money that is invested is always available to you without the original investment going down when the stock market falls. Since it is a very safe investment, it allows an investor to sleep well at night.

Some Republicans in Congress are making the argument that the G fund pays interest that is too high as there is no risk with the investment. The report from the Committee on the Budget in the House makes this observation regarding the G fund:

“Securities within the G-Fund are not subject to risk of default. Payment of principal and interest is guaranteed by the U.S. Government. Yet the interest rate paid is equivalent to a long-term bond. As a result, those who participate in the G Fund are rewarded with a long-term rate on what is essentially a short-term security. This could save up to $32 billion over 10 years.”

Since the federal budget is bleeding in red ink, despite record revenue coming into government coffers, a recent proposal would cut interest paid by the G Fund to an interest rate comparable to that of a standard money market fund. That means the federal government would have more money to spend without borrowing. It would, of course, also reduce the rate of return for TSP investors.

If this proposal were enacted, it is likely that a number of G fund investors would take their money out of the G fund. Many of the dollars invested would be transferred to other TSP funds.

Despite the strong negative reaction to cutting G fund interest rates, the net result could actually benefit TSP investors. Here is why.

Listed in this table are the compound interest rates on the TSP funds  from 2004 – 2014 as calculated by the Thrift Savings Plan:

G Fund F Fund C Fund S Fund I Fund
3.19% 4.89% 7.72% 9.44% 4.58%

This chart highlights an aspect of the G fund safety issue that may be overlooked by TSP investors.

An investor who invests only in the G fund over a period of time will probably make considerably less money than an investor who invests in the TSP’s stock funds. And, for someone who may be retired for 25 or more years after leaving federal service, the higher rate of return may be necessary for your money to last as long as your retirement will.

In effect, if the interest rate is cut on the G fund, and TSP investors decide to move their investments into other funds that have historically provided a substantially higher rate of return, removing some of the safety argument to encourage different investor behavior could be beneficial for these investors.

Those TSP investors who fear investing in stock funds out of fear of a falling stock market have a point. The stock market does not always go up. From 2004 – 2014, the stock market went up every year except for one. In 2008, the C fund dropped 38.32%. Of course, investors who sold their shares of the C fund during this big drop lost a great deal of money as the market started going back up in 2009 and has been going up ever since. Those who stuck with the stock funds have been repaid—but might have lost sleep throughout the months the stock market was dropping. (Annual returns for all TSP funds are listed at TSPDataCenter.com.)

The TSP points out that by diversifying your investments (spreading your money among different investments), “you reduce the likelihood that your entire account will be severely affected by dramatic fluctuations in any single asset or fund….Diversification is important because, at any given time, prices can move in different directions and by different amounts. By investing in all segments of the market (such as Treasury securities, bonds, and stocks), as opposed to just one segment, you’ll reduce the amount of volatility (risk) in your retirement account.”

A diversified portfolio will include both bonds and stocks. Bonds can provide a cushion for your investments when the market goes down. Stocks will usually provide a higher rate of return than bonds do over time, so the TSP stock funds can provide growth to help the financial assets grow that you may need when retiring.

So, for those investors who continue to invest in the G fund, even if the interest rate is lowered to rates comparable to money market funds, they will make less money on their investment—often less than the rate of inflation. However, they will likely make a higher return on their other investments with the money they may choose to withdraw from the G fund.

On the other hand, the rate of return for the C fund is not influenced as much by the rate of inflation as much as it is influenced by other factors. The value of stocks can be impacted by events in the world, political decisions, reported earnings of companies that are in the fund, and a host of other factors (including inflation). As a result, investors in the C fund have made more money to spend in their retirement years than an investor that put all of his investment into the G fund.

TSP investors have to make their own investment decisions based on personal circumstances and willingness to accept risk. A federal employee in his 20’s—who is just starting in a career— can afford to be more aggressive. A former—and now retired—federal employee who is withdrawing money from the TSP will be more conservative. Time is on the side of the younger employee who can afford the inevitable ups and downs of the market but who is likely to come out ahead by investing in stocks over several decades. A retired federal employee wants to ensure there is enough money to last an for the remainder of a lifetime but may not be able to afford going through a major correction in the stock market when retired and withdrawing money from the TSP.

To see the recommendations of two professional money managers to federal employees as to how to allocate their TSP contributions, be sure to see How Are Your TSP Funds Invested? and How Should I Allocate My TSP?.

Some investors are not willing to accept the risk of investing in stocks. For the investor who breaks out into a sweat when the market goes down substantially—as it always does sooner or later—investing only in the G fund provides a security blanket that may be well worth the loss in earnings from the stock market.

We wish all of our readers the best of luck in making their investment decisions.

© 2016 Ralph R. Smith. All rights reserved. This article may not be reproduced without express written consent from Ralph R. Smith.

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About the Author

Ralph Smith has several decades of experience working with federal human resources issues. He has written extensively on a full range of human resources topics in books and newsletters and is a co-founder of two companies and several newsletters on federal human resources.

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