As a federal government employee, one key source of retirement income is likely to be the Thrift Savings Plan, or TSP. This is the federal government’s version of a 401(k) plan, a popular retirement savings plan that’s offered by many private employers to their employees.
Your TSP account is automatically set up for you once you become a federal government employee. Each pay period your agency deposits an amount equal to 1% of your basic pay for the period into your account. You can also make tax-deferred or Roth contributions yourself if you want, which your agency will match. However, you’re not required to make any contributions.
The investment options available through the TSP include both individual funds and combinations of those funds known as Lifecycle funds. A description of each fund, along with risk level and return history is below:
Individual Funds
Government Securities Investment (or G) Fund
Inception date: April 1, 1987
Fund objective: to ensure the preservation of capital and generate returns above those of short-term U.S. Treasury securities
Risk level: Low
1-year and lifetime returns: 0.97% and 4.85%
Fixed Income (or F) Investment Fund
Inception date: January 29, 1988
Fund objective: to match the performance of the Bloomberg Barclays U.S. Aggregate Bond Index
Risk level: Low-medium
1-year and lifetime returns: 7.50% and 6.18%
Common Stock Index (or C) Investment Fund
Inception date: January 29, 1988
Fund objective: to match the performance of the Standard and Poor’s 500 (S&P 500) Index
Risk level: Medium
1-year and lifetime returns: 18.31% and 10.88%
Small Cap Stock Index (or S) Investment Fund
Inception date: May 1, 2001
Fund objective: to match the performance of the Dow Jones U.S. Completion Total Stock Market Index
Risk level: Medium-high
1-year and lifetime returns: 31.85% and 10.24%
International Stock Index (or I) Investment Fund
Inception date: May 1, 2001
Fund objective: to match the performance of the MSCI EAFE (Europe, Australasia, Far East) Index
Risk level: High
1-year and lifetime returns: 8.17% and 5.16%
Lifecycle (L) Funds
The Lifecycle Funds are a diversified mix of the five Individual Funds. The idea behind Lifecycle funds is to offer a single investment that is diversified, and is designed to offer the highest potential return for a given level of risk. The date gives you some idea of the level of risk, as it’s meant to reflect roughly when you plan to retire. Traditionally, the longer your investment horizon, the greater the weight of stocks can be in your portfolio. More stocks means higher returns over the longer term, but it also means your portfolio will lose more in bear markets.
That’s what we see in Lifecycle funds – the funds with dates further into the future have more invested in stocks and less in bonds. Further, the target allocations of each fund (except the L Income Fund) are automatically adjusted each quarter, gradually shifting from higher to lower risk and reward as the funds approach their target dates.
There are 10 TSP Lifecycle Funds:
L Income Fund
Inception date: May 1, 2001
Fund objective: for participants who are currently withdrawing their TSP accounts in monthly payments or who planned to begin withdrawing before 2020
Risk level: Low
1-year and lifetime returns: 5.15% and 4.32%
L 2025 Fund
Inception date: January 30, 2020
Fund objective: for participants who will withdraw their money beginning 2021 through 2027
Risk level: Low-medium
1-year and lifetime returns: N/A
L 2030 Fund
Inception date: August 1, 2005
Fund objective: for participants who will withdraw their money beginning 2028 through 2032
Risk level: Medium
1-year and lifetime returns: 11.26% and 7.01%
L 2035 Fund
Inception date: June 30, 2020
Fund objective: for participants who will withdraw their money beginning 2033 through 2037
Risk level: Medium
1-year and lifetime returns: N/A
L 2040 Fund
Inception date: August 1, 2005
Fund objective: for participants who will withdraw their money beginning 2038 through 2042
Risk level: Medium-high
1-year and lifetime returns: 13.16% and 7.61%
L 2045 Fund
Inception date: June 30, 2020
fund objective: for participants who will withdraw their money beginning 2043 through 2047
Risk level: Medium-high
1-year and lifetime returns: N/A
L 2050 Fund
Inception date: January 31, 2011
Fund objective: for participants who will withdraw their money beginning 2048 through 2052
Risk level: High
1-year and lifetime returns: 14.79% and 10.03%
L 2055 Fund
Inception date: June 30, 2020
Fund objective: for participants who will withdraw their money beginning 2053 through 2057
Risk level: High
1-year and lifetime returns: N/A
L 2060 Fund
Inception date: June 30, 2020
Fund objective: for participants who will withdraw their money beginning 2058 through 2062
Risk level: High
1-year and lifetime returns: N/A
L 2065 Fund
Inception date: June 30, 2020
Fund objective: for participants who will withdraw their money in 2062 or later
Risk level: High
1-year and lifetime returns: N/A
Building an Investment Portfolio
With the Lifecycle Funds, no portfolio construction is required on your part. All you have to do is choose the fund that corresponds with the date when you plan to withdraw your money. As noted above, the funds’ target allocations will adjust automatically, gradually shifting from higher to lower risk and reward as you near retirement.
The individual funds require a little more effort on your part when it comes to building an investment portfolio. The key is to construct a well-diversified portfolio that achieves your desired balance between risk and reward and is based on when you plan to retire.
Diversification is key here. This refers to the spreading out of your portfolio assets among funds that invest mainly in equities (or stocks), fixed-income (or bonds) and cash equivalents. Having a well-diversified portfolio can reduce the impact of market volatility by smoothing out returns across your portfolio. For example, sharp declines in funds that hold stocks can be offset by relative stability in funds that invest primarily in bonds and cash equivalents.
You can diversify your portfolio further by spreading out your assets among funds within a particular asset class. With stocks, for example, you can invest in funds that own the shares of international and domestic companies, as well as funds that own the shares of small-cap, mid-cap and large-cap companies. Diversifying by investing in different broad market areas – generally known as asset classes – can also help shore up returns when some asset classes perform poorly relative to other asset classes.
A good example of this is something we often see in portfolions – failing to diversify internationally due to a “home country” bias. The performance of stock markets varies greatly around the world, but many U.S. investors only invest in domestic stocks due to uncertainty or fear of investing overseas. That has been a good bet over the last several years as the U.S. has been among the top performing markets, but history tells us that there is an ebb and flow in market returns and it wouldn’t be unsual for the U.S. markets to underperform at some point it the next several years. Finally, less than half of the world’s economic activity occurs in the U.S., so not diversifying internationally by holding shares in the TSP’s International Stock Index Fund could mean missing out on potential opportunity overseas.
Unfortunately, one of the drawbacks of the TSP is the lack of investing options that include emerging market and foreign bond exposure. If you have retirement accounts outside of the TSP, you could achieve greater overall diversification by adding these exposures to these accounts.
You may also be able to use outside accounts to make your portfolio more tax efficient by putting high growth and high income funds in tax deferred accounts and tax efficient funds in taxable accounts. In order to do this, you’ll need to look at your portfolio as a whole and diversify across the portfolio as opposed to building “mini-portfolios” in each individual account. It is a good bit more work to do this, but if a sizeable percentage of your portfolio is in taxable investment accounts, it can be well worth it.
The Importance of Rebalancing
If you’re going to use the individual TSP funds to build your portfolio, you’ll want to rebalance periodicially. Rebalancing is the process of bringing your portfolio back into line with the overall allocation you want to maintain based on the level of return and risk you’re targeting.
Rebalancing is especially important when one particular asset class has risen or fallen sharply, particularly relative to other asset classes. For example, the stock market has soared since April 2020, after the markets panicked reaction the pandemic began to subside. Given this, it might be necessary to sell some stock holdings and use the proceeds to purchase funds that hold more bonds and cash equivalents in order to bring your portfolio back into the proper balance.
Building Your Custom TSP Portfolio
If you find investing in the TSP daunting, try beginning by understanding what sort of return you need and what level of risk is comfortable for you. Then take a look at whether individual funds or Lifecycle funds are a better fit for you given the issues we’ve outlined above and the need to rebalance individual funds periodically. If, after weighing your options, you’d like some professional help from a fee-only financial advisor with extensive experience in Federal retirement benefits, you can schedule a complimentary introductory call with us here.
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