Reader Question – Does the TSP G Fund Count as a Bond or Cash in my Asset Allocation?

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A reader wrote in and asked the following question:

Hi there. I thoroughly enjoy your website! When determining what my current asset allocation is, should I consider the TSP’s G Fund as “cash” or as a bond fund? I have a Vanguard account, and their website shows you these great “pie charts” reflecting one’s asset allocation. But what’s the best way to think of the G Fund in this context? Thanks a lot!

The Answer – It’s a Bond Fund

I can see why people might consider the G Fund a cash equivalent in their asset allocation, but I think it is best considered a bond because it is not liquid and is paying intermediate-term interest rates. Plus, Personal Capital agrees with me.

What is a cash equivalent? Here’s what Investopedia says:

Cash equivalents are one of the three main asset classes, along with stocks and bonds. These securities have a low-risk, low-return profile and include U.S. government Treasury bills, bank certificates of deposit, bankers’ acceptances, corporate commercial paper and other money market instruments.

The G Fund invests in “a nonmarketable short-term U.S. Treasury security that is specially issued to the TSP.” That makes it sound like a Treasury bill, which is listed as a cash equivalent above, but remember that the G Fund offers you a free lunch. It is a short term security but the interest rate it pays is:

based on the weighted average yield of all outstanding Treasury notes and bonds with 4 or more years to maturity. As a result, participants who invest in the G Fund are rewarded with a long-term rate on what is essentially a short-term security. Generally, long-term interest rates are higher than short-term rates.

In other words, it is really a hybrid between a short and long-term Treasury.

The other aspect of the G Fund that makes it a bond and not a cash equivalent is that it is not liquid. In other words, because it is in a retirement account you can’t sell it and use the proceeds to buy a car, deal with an emergency, or whatever else you need it for. Cash equivalents like CDs, money market accounts/funds, checking/savings accounts, or cold hard cash are all accessible and could be used for these purposes. Unless you are retirement age and withdrawing from your TSP account, the only way to get to the G Fund would be to take out a TSP loan, which I would not recommend.

Just to double check myself, I went to my favorite tool to automatically track my asset allocation, Personal Capital, to see what they considered my G Fund holdings. Personal Capital is also considering the G Fund a U.S. Bond holding.

3 thoughts on “Reader Question – Does the TSP G Fund Count as a Bond or Cash in my Asset Allocation?

    BRW said:
    November 8, 2019 at 08:48

    But if you are retired and able to withdraw from the g fund without penalty, except for tax due, does that make it liquid?

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    Donald said:
    November 29, 2019 at 01:33

    I would disagree with your characterization of the G fund as a bond fund. I will agree that the G fund is a free lunch, albeit a less filling lunch currently given a relatively flat yield curve.

    Specific asset classes have specific return drivers and behave in somewhat predictable manners in given investment environments. The G fund does not behave at all like a Treasury bond or Treasury note. It performs exactly like a cash equivalent. Since the G fund has an effective duration of zero, it is not affected by the directions of interest rates as a bond would be. As I am sure most people know, that as market interest rates change, the value of the a bond changes accordingly. As interest rates fall, all things being equal, the value of an existing bond goes up. The reverse is true in a rising interest rate environment. I won’t get into the weeds with the discussion of bond duration and convexity other than to say that the longer the duration of a bond the greater the magnitude of the change. For example, a newly issued 30 year Treasury bond would drop in value approximately 22% if 30 year yields increased 1% while a 10 year bond would only drop approximately 9% with a 1% increase in 10 year yields. This is how bonds operate. The G fund does not operate this way.

    If you have used the G fund as a bond holding for the past 20 years you have not participated in the long bull market in bonds caused by an almost uninterrupted decline in yields. But, on the flip side, if 10 year yields tripled tomorrow you would lose no money. While bonds would be hammered, you would actually see an uptick in the yield you receive.

    Personal Capital may consider this a bond fund but if I were a hedge fund manager designing a risk parity portfolio and had access to the G fund it would clearly go in the cash equivalents bucket given its volatility and return profile.

    Lastly, market liquidity is not defined by your ability to sell an asset and buy a car with it. Liquidity is the function of one’s ability to buy or sell an asset without an appreciable effect on its price. I could buy or sell $10 million of Treasury bonds or notes as soon as the market opens without moving the price more than a cent or two. The market is incredibly deep. The same is true of the G fund. Conversely, I could sell 50,000 shares of a thinly traded microcap in my taxable account and watch the price plummet. That’s an illiquid investment…..but I could go buy a car with the proceeds as soon as the trade settled.

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