By: Lyn Alden

The G Fund is the most popular fund within the TSP, accounting for over $200 billion in retirement savings alone. This article breaks down the G Fund to show what makes it truly unique among treasury investments.

See also: G Fund Downside? Low returns

What Makes the G Fund Special

The main benefit of the G Fund is that it pays relatively high interest rates comparable to 10-year treasuries, while enjoying a very low interest rate risk normally only associated with shorter-duration investments like 90-day T-bills. In other words, it has arguably the best risk/reward ratio of all U.S. government debt investments. Normally, the higher the interest rate you want, the longer duration you must buy bonds for, which opens you up to more interest rate risk. The G Fund is the exception.

A lot of factors can change the prevailing interest rate, with the Federal Funds Rate set by the U.S. Federal Reserve being a prime factor. A simple example can illustrate how changing interest rates affect bond prices.

Suppose you pay $1,000 for a bond that will pay you 4% ($40) per year for the next 30 years, and at the end you’ll get your principal back. You can either hold the bond for the full duration, or sell it to another investor at any point, if you can find a buyer and agree on a price. Now, suppose that a year later, the prevailing interest rates increase, and currently issued bonds with the same amount of default risk pay 5% ($50) per year. Now, if you were to try to sell your older bond before maturity, you’d unfortunately have to sell it at a lower price than you paid for it, because from the viewpoint of a bond buyer, why would they buy a bond that pays 4% per year instead of currently issued bonds that pay 5% per year, if they have the same risk? To fix that disparity, the older bond would have to be discounted to $800 and sold at that price, because at $40/year in interest, that new lower principal price would give it a 5% interest rate to match current bonds.

In reality, the calculations are more complex and take into account the remaining time to maturity using discounted cash flow analysis, but this exemplifies the core issue. Bond prices for existing bonds decrease if interest rates increase, because they must re-adjust to match the current rate of return of current bonds. And the longer duration that a bond exists for, the more interest rates could change during its lifetime, and the more significant the bond re-pricing could be.

Bonds with shorter durations are considered lower overall risk (assuming they have the same default risk, like they are issued from the same source), and thus they pay lower interest rates.

The G Fund, however, gets around that problem. It calculates the interest rate it pays to TSP investors based on a collection of long-term U.S. treasuries, with a current average maturity of 11 years. But, these treasuries are redeemable by the TSP to the Treasury on any business day at full principal, and as such, they have negligible interest rate risk. The government is giving TSP investors a special deal.

Private investors generally cannot buy these investments. Outside of the G-Fund, they’re only available to myRA investors, and with a maximum of just $15,000.

This chart from the G Fund fact sheet shows how the G Fund offers superior interest rates compared to short-term T-Bills, even though they have similar risk profiles:

And this chart from the St. Louis Federal Reserve shows long-term returns for 10-year treasuries over the same period, which match up quite closely to the G Fund’s returns on the previous chart:

Despite being a low risk investment, the G Fund does come with some risks, and is usually not ideal for putting 100% of your retirement savings into, as some investors do. In a future article, I plan to shed some light on the lesser-known downsides of this otherwise stellar fund.

Lyn Alden is a financial writer and an engineer, and holds a bachelor’s in engineering and a master’s in engineering management, with a focus on financial modeling and resource management. She specializes in analyzing and presenting financial data. Her investment work can be found on LynAlden.com.