Whether lower interest rates mean happy days for TSP investors
"As far as the TSP is concerned, we're probably in the future going to see a lower rate of return for the G fund," Arthur Stein said.
With a lot of publicity, the Federal Reserve Board of Governors decided to lower the benchmark for the federal funds rate last week. Panacea or no big deal. Certified financial planner Art Stein of Arthur Stein Financial joined the Federal Drive with Tom Temin to discuss how he thinks the new interest rates will affect the Thrift Savings Plan’s various funds.
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Interview transcript:
Tom Temin Art, let’s begin with the precision of that language, lowering the benchmark for the federal funds rate. What does that actually mean? Translate for us?
Art Stein The Federal Reserve really only directly controls one interest rate, and it’s a very obscure one, or it would be except for this. The federal funds rate is the interest rate that banks charge each other when they loan money to each other. Like if one bank has too much money in reserve, it will give an overnight loan to a bank that doesn’t have enough. But that interest rate affects all other interest rates in varying degrees. It most directly affects short term interest rates, i.e. interest rates on short term government bonds. But then that just filters through the whole economy. And as a result, we have already seen declines in interest rates for things like, you know, some high yield bank accounts, short term government bonds and various other things. But now that it’s actually there, we should see, well, mortgage rates have already come down a lot, partly as a result of the anticipation that this would happen. We’re going to see home equity lines of credit should come down. Credit card interest rates would come down, maybe a little, maybe not at all. Auto loans should be slightly lower. And it also affects things like foreign exchange and things like that. Now, as far as the TSP is concerned, we’re probably in the future going to see a lower rate of return for the G Fund. And how much is just very hard to tell, Tom. And increases in the F fund, which we’ve already have started to happen.
Tom Temin The G Fund being the Treasury bonds.
Art Stein The G fund is like a bank account only with a better interest rate. It doesn’t fluctuate in value, it’s guaranteed by the government. It’s considered a short term bond fund. No one’s ever seen the bonds. It doesn’t matter. The F fund is a typical bond fund. And it goes up and down as interest rates go up and down. And it has had very poor returns over the last 2 or 3 years. Some of the worst we’ve ever seen. But now we’re starting to see big increases in the F fund.
Tom Temin Well, what’s the mechanism there? While you look up some examples, what causes the those bonds to go up in yield as just as the Treasury bonds are going down?
Art Stein OK. See, the thing with bond funds, and bonds is when interest rates go down, the value of existing bonds goes up, because they’re still paying the older higher interest rate. So they are more desirable. And because this is going to lower interest rates in the economy, we’ve already seen the F fund is up 4.8% this year, and it’s up 10% over the last 12 months, which is a huge increase for a bond fund. And finally this year is the first time in a long time that the F fund has been outperforming the G Fund, which is typically what happens, but not always. So year-to-date, the F fund, as I said, is up 4.8%. The G fund is up 3.2%.
Tom Temin We’re speaking with certified financial planner Art Stein of Arthur Stein Financial. So then you’re presuming that it’s a good bet anyway, without predicting the future, of course, that the fund would continue to do well in this era of slightly lower interest rates.
Art Stein It may be Tom, that all the positive effect has already happened, and that’s why we’ve seen the F fund up 4.8% this year. Maybe interest rates don’t go down much more between now and the end of the year. And the F fund doesn’t go up a lot more, but 4.8% for the F fund is still a very good year.
Tom Temin And those [certificates of deposit (CD)] that people were buying over the last couple of years, forget about those. That’s not going to be around, is it?
Art Stein Well, the interest rates, savers for people who are saving in bank accounts and with CDs, there is a negative effect here, because they’re going to see lower rates of return on their bank accounts and CD. So if you have an existing CD feel good, you don’t want to cash it in because you’re not going to get that intrest rate again. Not going to get as high an interest rate.
Tom Temin And then, of course, what is the effect? It’s hard to tell because of things. There’s so many factors that affect the stock market. But if the belief is that this is good economically, and may be good for capital investment, could this be good for stock funds?
Art Stein It is considered a positive for stock funds. But once again, stock funds are already up quite a bit. The C fund is up 21% this year. That’s a really fabulous year. And if it doesn’t go up any more, we’ve still had a great year. The S fund, the small and medium size U.S. company fund is up 11%. The International Stock Fund is up 12%. It’s been a great year for stocks. And one of the reasons is the anticipation that interest rates were going down is considered a positive for the economy and for corporate profits, because their borrowing costs go down. And something like the auto industry, if the rate on auto loans declines, more people can buy cars. It’s good for the auto industry.
Tom Temin Well, the average TSP investor then sounds like they should kind of just have faith, but hang on to what they’re doing now.
Art Stein Yeah. The one thing I would point out is the average TSP investor has a very small allocation to the F fund. And that’s always been true. And so they’re not going to benefit from the big increase that we’ve had in the F fund so far. And it’s always been a problem with TSP investors. When they do bond investments, they just stick it all in the fund, even though most years, but certainly not all, the F fund outperforms.
Tom Temin Right. And these tend to be lagging activities. In other words, if inflation should somehow take off again, and the Federal Reserve used the end of apparently the end of inflation as their reason for saying, well, now we can lower interest rates and help the economy now that inflation is under control. Kind of a classic move, and just as political now as it was 40, 50 years ago when people started learning about monetary policy. But should interest rates go up, it doesn’t mean the Federal Reserve doesn’t keep a hand on a switch with hair trigger adjustments. They’re usually lagging because of the political debates about what they’re doing.
Art Stein Well, it’s not just political debates either. It’s like people don’t generally agree on whether the increase or decrease is needed. It’s a lot of gray area. But if inflation picks up again, yes, we could see an increase in the federal funds rate, and then that would be an overall increase in interest rates and the economy.
Tom Temin And getting back to the G fund then, what can we expect with that poor country cousin?
Art Stein It’s not a poor country cousin. It’s the most popular of the funds except the C fund. The G fund interest rate is set in a sort of very complex way. It’s the average rate of return on 191 different bonds, U.S. Treasury bonds, that have a maturity of four years or more. And it’s reset at the beginning of each month. So it’s very likely that the returns starting next month, which is not very far away, will be slightly lower than it has been. Again, it’s probably not going to be a huge change, but, it’s going to happen. And if interest rates keep going down, there’s talk about the fed lowering the federal funds rate. Before the end of the year, then we, again, would see a lower rate of return in the fund. But of course, we’re never going to see a negative return in the G fund. It’s just a question of how much it’s going to go up each month.
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Tom Temin
Tom Temin is host of the Federal Drive and has been providing insight on federal technology and management issues for more than 30 years.
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