Bonds are loans to companies, municipalities and even the federal government. When a town wants to build a bridge or a company wants to build a warehouse, they issue bonds to raise money. In the old days bonds were physical pieces of paper with coupons you tore off and turned into the issuer for payment at pre-determined intervals.
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These bonds are rated by companies like Moody’s for credit worthiness with a rating from AAA to D. Like your own credit score an 850 rating is good for you since your interest for a mortgage will be low, and a bad credit score of 400 is going to cost you in high interest rates because you obviously suck at paying people back and are an obvious risk. A bank will only take on the risk if it is lucrative for them to give you a chance with a loan. These bad credit companies are very high yield bonds know as “junk bonds”. They have a high risk of default, but if they do pay off the loan then it would be worth it!
Both the F Fund and the G Fund deal with loaning out money and hope on those parties paying you back at full term with interest. These securities are called bonds, where the writers of the bonds will make interest and principal payments to you over time. The F Fund matches the performance of the Bloomberg Barclays U.S. Aggregate Bond Index, a broad index representing the U.S. bond market. This is indexing with money lending instead of stocks.
How many loans does this fund cover? Well, in December 31, 2015, the index included 9,720 notes and bonds. Its yield to maturity was 3.09%. The average duration of these bonds was 5.31 years. TSP is limited by law to only include super safe bonds only in the USA market of a rating of BBB- or better as safe investments, hence the low 3% yield. These guys are going to pay back, so you can’t really charge too much.
The G Fund is a U.S. Treasury security specially issued to the TSP. Payment of principal and interest for G is guaranteed by the U.S. Government. Thus, there is no credit risk as compared to the F fund which has a super small risk of default. However bonds of the F Fund are exposed to market risk where the risk that the value of the underlying securities will decline, and prepayment risk the risk that a security in the fund will be repaid before it matures. Since its infinity low risk we can only get a consistent 2% return with the United States government. This sucks because inflation is around the same rate, so it is like not making money at all.
US investment grade bonds and Government Bonds are boring because they will most likely pay the 3% average interest or 2% with the feds. There is no risk of loss, but there is also no return, This is why the Life cycle funds shift CSI to F and G as you age closer to death. No need to have 30% return every year when your 99 years old since you essentially only have a few years to spend your money before your spoiled rotten kids get it all in the will.
Again Dave Ramsey and I don’t like the Lifecycle funds because they are way too conservative. I have been told if you do life cycle to aim for your proposed death date as your retirement date, since we might live to 130 in the future, who knows? This will delay the shift to all F and G to maximize earnings and switch to a conservative income only portfolio later in life.
Now there are many ETFs that dabble in the riskier side of the bond market there is “JNK” which is SPDR Barclays Capital High Yield Bond ETF. You can also go outside the American market and invest in “SOVB” Cambria Sovereign Bond ETF which is the foreign equivalent of the G fund just for countries that really need the money, with pretty questionable credit, some as low as a B rating. However this risk has resulted in some sweet returns paid in dividends. My $990 investment via Robin Hood has earned me $14.63 and $9.46 in dividends in 6 months, 4.8% annualized yield!
This concludes the review of all the Funds of TSP. Check out my write up on C,S,I in previous entries. Next up, what is TSP missing and what can you do about it.