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Default risk and retirement savings

Chris Farrell Jul 14, 2011

Question: I work for the government and have a TSP account with the majority of my money in the government security fund which is a no risk fund. What will happen to my TSP if the government defaults? Will my money still be there? Should I get that money out of that fund? Other funds are risk funds. I have over 200,000 and I am putting 10% in each pay check. As I have been told the more the better but now I don’t know. I am considering taking only 5% out. Good or bad? I will retire in 6 years. Jan, Midway, GA

Answer: First of all, it’s a disgrace that we even have to address a question like yours. Ever since Alexander Hamilton, the brilliant financier and first Treasury Secretary, the world’s wealthiest nation has always paid its debts. Every investing primer published by mutual fund companies and investment textbooks describe U.S. Treasuries – bills, bonds and notes — as default-free investments. When it comes to credit quality, Treasuries are as safe as it gets.

Yet there’s serious talk in Washington and on the campaign trail by high-profile people willing to push the U.S toward the risk of default. The trigger for how the unthinkable became even remotely possible is the government’s $14.29 trillion debt ceiling limit. The risk of default sharply increases unless Congress raises the debt ceiling by August 2. Yes, the government can scramble for a time, making difficult choices over who gets paid and who gets an IOU, but eventually the federal government would run out of room for maneuver. Long before then the markets would lose confidence in U.S. Treasuries, pushing up interest rates and shattering the global economy.

That said, how worried should you be about the value of your government security fund? I wouldn’t be too worried about default. For one thing, the political saber-rattling hasn’t upset global investors. The general mood among investors seems to be that speculation about possible default scenarios should remain just that: Speculation.

How do we know this? Despite all the vituperative brinkmanship in Washington, as I’m answering your question the yield on 3 month Treasury bills is at 0.015% and the I year T-bill 0.157%. Those are not Armageddon-type yields. Default is truly unlikely.

A fiscal disaster is possible. In that case our risk is that interest rates will rise, driving down bond prices. (Bond prices and bond yields go in opposite directions. When bond prices fall, yields rise and vice versa.)

What’s more, even if the unthinkable did come to pass the pressure from investors–from American retirees to the Chinese government–would be too great for Washington not to make good on all its debt obligations. In this sense your investments in U.S. Treasuries remains is safe.

I would continue to contribute to your retirement savings plan. It’s still true: The more the better when it comes to retirement savings.

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