Why is the TSP F Fund Losing Money? Understanding Fixed Income in a Rising Rate Environment

The TSP F Fund, designed to provide stability and income through investments in U.S. government bonds, has indeed experienced periods of losses. The primary reason for this is the inverse relationship between interest rates and bond prices. When interest rates rise, the value of existing bonds with lower, fixed interest rates decreases, leading to potential losses for bond funds like the F Fund.

The Core Principle: Interest Rates and Bond Prices

Imagine you hold a bond paying 3% interest. Suddenly, newly issued bonds offer 5%. Your 3% bond becomes less attractive, and its market value drops to compensate. This is the fundamental principle driving the F Fund’s performance. The fund holds a portfolio of bonds, and as the Federal Reserve raises interest rates to combat inflation, for example, these existing bonds lose value, impacting the fund’s overall return. The longer the maturity of the bonds held in the fund, the more sensitive they are to interest rate changes. The F Fund, holding a significant amount of long-term government bonds, is particularly vulnerable.

Factors Influencing Bond Yields and F Fund Performance

Several factors beyond just the Federal Reserve’s actions influence bond yields and subsequently, the F Fund’s performance:

• Inflation Expectations: Higher inflation expectations typically lead to higher bond yields as investors demand a greater return to compensate for the eroding purchasing power of future interest payments.
• Economic Growth: A strong economy often leads to increased demand for credit, putting upward pressure on interest rates.
• Geopolitical Events: Global instability can lead to “flight to safety,” driving demand for U.S. government bonds and temporarily pushing yields down. However, geopolitical uncertainty can also contribute to inflation and higher rates longer-term.
• Federal Reserve Policy: The Fed directly influences short-term interest rates through actions like adjusting the federal funds rate and indirectly influences longer-term rates through quantitative easing (QE) or quantitative tightening (QT).
• Fiscal Policy: Government spending and borrowing can also influence interest rates. Large deficits typically put upward pressure on rates as the government needs to sell more bonds to finance its spending.

Beyond Interest Rate Sensitivity: Other Considerations

While rising interest rates are the dominant factor, other elements can play a minor role in the F Fund’s performance:

• Credit Risk: The F Fund invests primarily in U.S. government securities, considered virtually risk-free. However, minor holdings in agency securities (like those issued by Fannie Mae or Freddie Mac) carry some, albeit very low, credit risk.
• Liquidity: While government bond markets are highly liquid, periods of market stress can temporarily reduce liquidity and impact prices.
• Expense Ratio: The F Fund has a very low expense ratio (typically under 0.03%), so this is a minimal factor impacting returns.

Navigating a Rising Rate Environment with the F Fund

While the F Fund can experience losses in rising rate environments, it still serves a valuable purpose in a diversified portfolio:

• Diversification: Bonds generally have a low or negative correlation with stocks, providing a cushion during equity market downturns.
• Income Generation: The F Fund provides a steady stream of income, albeit potentially lower than in periods of falling rates.
• Inflation Hedge (Long-Term): While bonds can suffer in the short-term from unexpected inflation, they can act as a hedge over longer periods, as interest rates tend to rise to compensate for inflation.
• Stability: Compared to stocks, bonds are generally less volatile, providing a stabilizing influence on a portfolio.

Long-term investors should consider their overall asset allocation and risk tolerance when evaluating the F Fund’s performance. Short-term fluctuations are normal, and trying to time the market by moving in and out of the F Fund can be detrimental. Dollar-cost averaging (investing a fixed amount regularly) can help mitigate the impact of interest rate volatility.

TSP F Fund FAQs: Delving Deeper

Here are some frequently asked questions to provide further insights into the F Fund:

What exactly does the TSP F Fund invest in?

The TSP F Fund primarily invests in the Government Securities Investment Fund (G Fund). This G Fund, in turn, invests in short-term U.S. Treasury securities specially issued to the TSP. It can also invest in U.S. government agency bonds with maturities generally in the intermediate to long-term.

How is the F Fund different from the G Fund?

The G Fund is unique to the TSP and offers a guaranteed rate of return based on the average yield of U.S. Treasury securities with maturities of four or more years. The F Fund, on the other hand, invests directly in bonds and its value fluctuates with market interest rates. The G Fund effectively eliminates interest rate risk, while the F Fund is subject to it.

What is the average maturity of the bonds held in the F Fund?

The average maturity of the bonds in the F Fund fluctuates depending on market conditions and investment strategy but typically ranges from 5 to 10 years. Longer maturities mean greater sensitivity to interest rate changes.

Should I sell my F Fund holdings if interest rates are rising?

That depends on your investment horizon, risk tolerance, and overall financial goals. Selling low during a rising rate environment can lock in losses. Consider consulting with a financial advisor before making any major changes to your investment strategy.

How does inflation impact the F Fund?

Unexpected inflation is generally negative for bonds, as it erodes the purchasing power of fixed interest payments. Central banks typically raise interest rates to combat inflation, which further depresses bond prices.

Is the F Fund a safe investment?

The F Fund is considered a relatively safe investment compared to stocks, as it primarily invests in U.S. government securities. However, it is not risk-free. It is subject to interest rate risk and can experience losses, especially during periods of rising rates.

What is the expense ratio of the F Fund?

The expense ratio of the F Fund is very low, typically less than 0.03%. This means that for every $10,000 invested, you would pay less than $3 in annual expenses.

How often is the F Fund’s share price updated?

The F Fund’s share price is updated daily, reflecting changes in the value of its underlying bond holdings.

Can I use the F Fund to diversify my portfolio?

Yes, the F Fund can be a valuable tool for diversification, especially when combined with stock market investments. Bonds generally have a low or negative correlation with stocks, helping to reduce overall portfolio volatility.

What are the advantages of investing in the F Fund compared to individual bonds?

The F Fund offers diversification (exposure to a broad portfolio of bonds), professional management, and liquidity (easy to buy and sell shares). Buying individual bonds requires more research and management and may be less liquid.

Will the F Fund ever recover its losses?

Potentially, yes. If interest rates eventually stabilize or decline, the value of existing bonds in the F Fund could increase, leading to a recovery in its share price. Additionally, the fund continues to generate income from interest payments, which contributes to overall returns over time.

What is the long-term historical performance of the F Fund?

Historically, the F Fund has provided stable returns with relatively low volatility. However, past performance is not indicative of future results, and periods of rising rates can significantly impact its short-term performance. Reviewing historical data provides context but shouldn’t solely drive investment decisions.

In conclusion, while the TSP F Fund can experience periods of losses due primarily to rising interest rates, it remains a valuable component of a well-diversified retirement portfolio. Understanding the factors influencing bond prices and considering your individual circumstances are crucial for making informed investment decisions.