The Thrift Savings Plan’s G Fund is in a class by itself. It is a government securities investment fund that guarantees against loss of principal while offering the returns of more risky, longer-term Treasury bonds.

While the G Fund’s returns are similar to the yield provided by 10-year Treasury bonds, the G Fund is not comparable to a bond investment. Bonds and bond funds, like TSP’s F Fund, can and sometimes do lose money. Treasury bonds, for example, guarantee their interest payments and the value of the bond, if redeemed, at maturity. Along the way to maturity, however, the bonds may be traded on the secondary market, and the value of the bond will rise and fall in response to changes in market interest rates, among other factors.

The G Fund, however, is not subject to the same risk of principal loss. The G Fund is really more like a cash investment with an extraordinary interest rate – a “juiced-up money market” security. According to TSP data, the G Fund’s rate of return has historically exceeded the rate of inflation and outperformed the returns of short-term Treasury bills. This is one of the reasons that I usually favor the G Fund for the cash component of my clients’ investment portfolios.

The G Fund’s outstanding risk-adjusted rate of return – the return it produces relative to the risk it imposes – is, in part, the result of the TSP’s incredibly low expense factor. It is also the result of government guarantees and the way the TSP manages the G Fund’s assets. When combined, these factors create a unique investment fund that is unmatched anywhere else.

But don’t let the G Fund’s unique benefits fool you into thinking that it’s the only investment you need. In fact, most TSP accounts, particularly those of participants who are still working, should not be heavily invested in the G Fund. In most cases I’ve worked on, the G Fund holdings should represent 10 percent or less of the TSP assets. Exceptions most frequently apply when the TSP participant is over age 70 or when the TSP account contains a minority share of a larger portfolio.

I was recently asked how the G Fund compares with Treasury Inflation Protected Securities (TIPS).

The two are not the same. The G Fund is liquid. That is, you can always redeem your shares without risking loss. While the G Fund does not guarantee inflation protection, it is highly likely to provide it, and then some.

TIPS guarantee your principal against inflation and pay a fixed rate of interest on that principal every six months until maturity. If you want out of your TIPS investment, you must sell it on the secondary market and take what the market will give you. This means that a TIPS portfolio does subject you to principal risk between the time you buy it and the time it matures.

A comparison of the historical returns for the G Fund and the Barclays iShare TIPS Exchange Traded Fund (ticker symbol: TIP), which is based on an index of the TIPS market, clearly demonstrates how different the annual returns can be between the two. From 2004 to 2009, the G Fund’s annual returns were: 4.30, 4.49, 4.93, 4.87, 3.75 and 2.97 percent. The annual returns for TIP during the same period were: 8.20, 2.64, 0.31, 11.44, -2.53 and 11.37 percent.

When considering various investment options, you should keep in mind that they are a means to an end, not the end in themselves. Their value lies in how they can help you to achieve your goals, not in their intrinsic characteristics alone. I have yet to meet a retiree whose true financial goal is to keep pace with inflation. Retirement goals tend to be things like maintaining a certain standard of living or helping younger generations achieve their goals. Considering potential returns in the context of the predictability of those returns is critical to judging an investment’s value.

For example, my firm’s estimated annual return for the G Fund is about 5.5 percent while this estimate is closer to 6 percent for TIPS. When returns alone are considered, TIPS look more attractive. Our estimated standard deviation – a measure of the uncertainty of realizing that return – however, for TIPS is more than twice that for the G Fund.

So, if you are trying to decide between the G Fund and TIPS for your portfolio, you should ask yourself whether a modest increase in expected return is worth the additional risk you’ll take to try to get it.

Written by Mike Miles
For the Federal Times
Publication May 3, 2010