Index funds, such as those available through the Thrift Savings Plan, attempt to duplicate the returns of a given index, such as the S&P 500. Such funds offer these advantages:
* Asset class exposure. Investing in an index fund assures you of getting the return of that asset class. With an S&P 500 index fund, for example, you can be confident of good performance in a year when large-cap stocks do well.
* Low costs. Index funds do not require as much research so they generally have low fees. The higher a fund’s expense ratio, the better it has to perform, just to break even with a low-cost fund.
* Low turnover. Especially in large-cap indexes, where few changes occur, managers seldom have to sell a stock and buy another. High turnover hurts performance because this activity incurs trading costs, which are passed through to investors.
* Low taxes. High-turnover funds may realize taxable gains, which also are passed through. On the other hand, low-turnover index funds tend to be tax-efficient.
While such funds—in the case of the TSP, all except the government securities fund—move up and down with the markets in general, their efficiency enables them to beat the returns of many actively managed investment funds–and even many other funds tracking the same indexes, after taking the extremely low TSP management fees into account.
This indexing also provides the same type of benefits in the lifecycle funds. The government securities fund is separate and does not fluctuate day to day with the markets but rather pays a fixed return for a month.