Would TSP Investors Abandon the G Fund With Negative Interest Rates?

By on June 16, 2016 in Retirement with 67 Comments

Image of downward facing red arrow depicting negative interest rates

Now that 10-year yields on German bonds have fallen below zero for the first time and Japanese 10-year yields have dipped to record lows of negative 0.17 percent, will US Treasury bonds follow the same path?

A rate of less than zero means that investors will receive less than $1.00 back for every dollar invested in a bond with an interest rate that is below zero. Especially for a person who is retired, a guarantee of losing money in an investment is not an attractive option.

And, if Treasury bills go even lower, what would happen to interest rates paid by the G fund?

The G Fund’s investment objective is to produce a rate of return higher than inflation while avoiding exposure to credit (default) risk and market price fluctuations. It has done a good job of accomplishing this since the Thrift Savings Plan (TSP) was established.

Last year, the G fund paid investors a rate of 2.04%. That is not the lowest rate this fund has ever paid. In 2012, it paid 1.47% for the year.

G fund rates have not always been so meager. When the TSP was first formed, investors were paid 8.81% in the first and second years of the TSP fund. A rate of that amount with little or no risk for investors was hard to turn down, although the C fund in those same first two years returned 11.04% and 31.03%.

While there is a correlation between bond rates in Germany, Japan and the United States, there are a couple of significant differences.

Inflation is Germany is mildly negative and Japan is undergoing deflation. Inflation in the U.S. is now just above 1% as of the end of the first quarter for 2016. As we recently reported, the chances of a cost of living adjustment for Social Security recipients and federal retirees in January 2017 are not looking very good now because of very low inflation.

The safety of the G fund is probably the biggest reason that 36% of all Thrift Savings Plan (TSP) funds are invested in the G fund. For comparison, 27% of TSP investments are in the C fund. The percentage of funds in the C fund has gone up and the percentage in the G fund has gone down as the bull market has extended over the past several years.

The G Fund interest rate calculation is based on a weighted average yield of all outstanding Treasury notes and bonds with 4 or more years to maturity. As a result, participants who invest in the G Fund are rewarded with a long-term rate on what is essentially a short-term security. Generally, long-term interest rates are higher than short-term rates.

In plain English, this means the G fund is not likely to start charging TSP investors a fee for holding their money in the TSP in the near future. This is because while the rates on a 10-year Treasury bond are more likely to turn negative, longer maturity bonds would probably stay above zero for awhile. The G Fund interest rate is calculated as an average of the Treasury bills. In effect, rates paid to TSP G fund investors might go even lower than they are now but still stay above zero.

Would TSP investors abandon the G fund if interest rates were to turn negative?

As Michael Wald wrote in What Would Happen to the TSP if Interest Rates Turned Negative?“Thinking about negative interest rates would have been unimaginable only a few years ago but, while very unlikely, the possibility of being charged to store your money in the G Fund is thinkable as opposed to five years ago when the possibility existed only in the realm of fantasy.”

Chances are, negative interest rates would likely drive many G fund investors out of the most popular TSP fund and into other TSP funds such as the C fund in the hope that there would be a rate of return on stock prices.

But, since we have not experienced this scenario in the TSP, we will not have an answer about how TSP investors would react unless or until we go through the experience of a negative interest rate environment.

© 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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