Inflation Fears and Its Impact On Your Retirement Funds

The performance of the F fund is impacted by interest rates and this fund can have a negative return for investors.

TSP investors have to look out for their own financial security in retirement–especially those who are under the FERS system.

It has taken awhile for this to get through to some people but there is little doubt this fact has registered with most TSP investors. doesn’t provide individual financial advice. Readers have too many different situations to give specific advice about what should be done at any time even if we knew how to predict the future. Having said this, we do find that observations on the investing climate and how this can impact TSP funds are a favorite subject among our readers.

So, without telling you how you should handle your TSP investments, here are several observations that may be useful to you in determining your own financial future.

A reader wrote in several days ago and asked: “The F fund is losing money for the past month according to your TSP tables. How can this fund lose money? I thought it was a safe investment with a fixed rate of return?”

The F fund is a safe investment. But that doesn’t mean there are not some risks associated with a bond fund.

How the F Fund Works

First, you need to understand what the F fund is and how it works.

The F fund is a “Fixed Income Index Investment Fund.” It is a bond fund. It tracks the overall performance of the American bond market.

Fixed Income

As one reader asked, “What does ‘fixed income’ refer to and how can there be any risk in the F fund if the income is fixed?”

Good questions. Here is some background that may be useful in understanding your F fund investment.

“Fixed income” refers to the amount of interest a bond will pay to an investor. This interest rate is fixed in advance. So, unlike the stock of a company, the issuer of a bond agrees in advance to pay a specific interest rate and, when the bond is purchased, you know in advance how much interest you will receive.

Interest Rates and Bonds

Despite the fact that the interest rate for bonds in the F fund are known in advance, there is some risk in this investment. The biggest risks in the current investing environment are inflation and interest rates.

We have had a period of extraordinarily low interest rates. These interest rates have been stable for several years. If you have money in a savings account in a bank, you know you are getting a very low interest rate on your savings–probably much less than 1% a year on a bank savings account. This has actually hurt many retirees who depend on money market accounts, bond funds and certificates of deposit for income. Their income has been dramatically reduced because of low interest rates.

It is unlikely that this abnormally low interest rate environment will continue. In other words, many investors are expecting interest rates to rise in the near future. Based on this expectation, they are adjusting their finances to reflect this.

This could be important to you. If interest rates do rise, this will likely have an impact your investment in the F fund. Here’s why.

Bonds in the F fund are generally long term bonds. That is, they do not mature for a number of years. A bond in the F fund may not mature for 5 years or more. When a bond is purchased for the fund, it will pay the rate of interest for bonds issued at that time. If interest rates go up in the future, the underlying interest rate of that bond does not change.

New bonds that are issued will pay a higher interest rate if inflation goes up. Since newer bonds pay a higher interest rate, the underlying value of the current bonds in the F fund will go down.

This means that the value of your investment in the F fund will also go down. Keep in mind that the F fund is not an actively managed fund. Here is the statement from the TSP web site: “The Barclays U.S. Debt index fund uses a ‘passive’ investment strategy of replicating the performance of the LBA index, rather than an ‘active’ investment strategy, in which the fund manager selects bonds on the basis of economic, financial, and market analyses.”

In plain English, this means that the fund doesn’t try to buy and sell bonds to reflect market conditions. It is a passive fund in that it reflects a well-known market index.

The F fund doesn’t drop in value very often–or at least it hasn’t happened for some time. But it did happen in 1994 when the F fund lost 2.96% and again in 1999 when the F fund declined 0.85%. And, if interest rates do go up this year, the value of your investment in the F fund could again be negative.

From 1994 – 2003, the average return of the F fund was 6.95% per year. That is a very good rate of return for a bond fund. During that same time period, the C fund (which is an investment in common stocks instead of bonds) returned an average of 10.99%.

But there were years during that 10 year period when stocks were a terrible investment. In fact, an investment in the C fund lost money for three straight years from 2000-2002. And some of these losses were significant. The C fund went down more than 22% in one year (2002). In terms of dollars and sense, to use an example that is overly-simplified, if you had $100,000 in the C fund at the start of 2002, you would have had only $80,000 at the end of the year assuming you did not invest any more money into the fund.

That type of fluctuation makes most of us very nervous. An investment in the F fund is not likely to have that much fluctuation and is generally a “safer” investment than stocks.

But you need to understand that you can lose money in the F fund. You are also likely to make more money in stock funds than you will in bond funds over an extended time period.

As a long term investor who wants to ensure your retirement funds are secure, you need both types of investments in your portfolio.

Now, here is something to give you food for thought. According to the Wall Street Journal, large investors in the bond market have lost money in the last few days because investors are bracing for higher interest rates. Some of these large traders are dumping their bonds. At the same time, investors in the F fund have seen their investment go down as well (check out our TSP tables from the link on the left hand side of this page).

So what does the future hold? Will interest again become a factor in our economy? Will bond prices fall if interest rates go up? What will be the impact of interest rates on stock prices and the C fund?

No one really knows the answers to these questions. Your best bet for investing your retirement funds is to have diversification in your portfolio. But readers who may have all or most of their TSP investment in the F fund may want to consider putting at least some of your hard earned money into other TSP funds as well.

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. Follow Ralph on Twitter: @RalphSmith47