Hold on to the F Fund


Negativity towards bonds, particularly Treasury bonds, has been peaking lately. For TSP investors, this may often mean avoiding the F Fund, which represents the aggregate United States bond market, and is the only bond fund available in the TSP.

But what about the G Fund? While the G Fund’s return is based on that of Treasury bonds, your investment in the fund is otherwise unlike a bond investment. Bonds bear the risk of loss. The G Fund does not. It’s like cash that pays a high rate of interest, not like a bond that might produce a positive or a negative return over any period shorter than its life.

The F Fund is designed to replicate the performance of the entire U.S. bond market, including corporate, U.S., state, municipal and agency debt instruments. The components of its return include the interest income received from the debtors and the changes in the market value of the bond — what the bond is worth on the secondary market if you were to sell it. The fund does not pay out the interest, and both components are accumulated in the shares’ price each day.

While the interest is always a positive amount, the change in market value can be either positive or negative. This means that the share price can go down if the loss in market value exceeds the interest income for the period being measured.

When most bonds are issued, the interest payment amount is fixed — not as a percentage, but as a dollar value. The yield produced by the bond is an after-the-fact calculation that converts the interest payments into a percentage of the price paid for the bond.

The relationship of market interest rates to changes in a bond’s value, and to the share price of the F Fund, is connected to the recent warnings against holding bonds. Rising market interest rates are bad for bond values, and with today’s low interest rates, is there any way for interest rates to go in the future but up?

This is sound logic, and I agree that the most likely return for bonds going forward is negative. There is a reason to continue to hold the F Fund in your portfolio, however, even though it will probably lose money over the next few years. The reason
is that you are also holding stocks — in the form of the C, S and or I Funds — or even elsewhere in your portfolio. Bond and stock values tend to be negatively correlated. That means that they often move in opposite directions at the same time.

Your portfolio should always hold stocks and bonds together, so that each is always hedged by the other. This will make your returns more predictable and, if done properly, significantly improve the odds of succeeding in achieving reasonable financial goals.

The potential for losses in bonds pales in comparison to that for an unhedged stock portfolio. If the stock market continues to rise and interest rates rise along with it, the gains from your stock holdings should dominate, and more than offset, the losses in your bond holdings.

If the stock market crashes, however, which it has done the last two times it has reached new all-time highs, those
bonds will likely jump in value, continue to pay interest, and reduce the magnitude of your loss. And when it comes to investing for retirement income, avoiding the worst losses is more important than earning a little more during the good years.

Mike Miles is a Certified Financial Planner licensee and principal adviser for Variplan LLC, an independent fiduciary in Ashburn, Va., specializing in retirement planning for federal employees. Email your financial questions to fedexperts@federaltimes.com and view his blog at blogs.federaltimes.com/federal-money.


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