The best thing about defined contribution plans such as the TSP is that they give you the opportunity to take charge of your retirement security. The worst thing about them is that they give you the responsibility to take charge of your retirement security.
For many people—especially those later in their careers or already retired who cut their retirement planning teeth on defined benefit programs such as CSRS and FERS—that is an uncomfortable tradeoff.
In defined benefit programs, the payout is set according to a formula—in the federal government, based on creditable service time and high-three salary average—and is the employer’s responsibility. In defined contribution programs, the payout depends on how much you—and the government, if you are under FERS—put in, for how long, and what types of return you achieve with your investment choices.
While the amount and length of your investments are largely under your control, investment returns depend on more open-ended choices. And unfortunately, the record has shown that the federal workforce is not full of Warren Buffets.
That’s the conclusion the TSP itself drew more than a decade ago after studying TSP investor behavior and finding several trends it found disturbing. Some were investing too conservatively for their age, some too aggressively. They were getting too little return for the risk they were taking on; or, looked at another way, they were taking on too much risk for the returns they were getting.
Worse still, they tended to sell stocks when they dropped and not return until well after the rebound had run. That is, they sold low and bought high, about the worst form of investor behavior.
These are just averages, of course. Many TSP investors have done very well in their investment decisions. They have hung on through scary times and benefitted from the rebounds afterward, or even have done a good job of timing when to get in or out of this or that form of investment. But on average, the TSP saw that many would be better off with a form of automatic pilot investing called lifecycle funds.
Thus the TSP offers five such funds, four with target dates (2020, 2030, 2040, 2050) geared to when the investor expects to begin withdrawals—or within about five years before or after those dates—plus the income fund, for those already taking withdrawals or planning to do so in the time just ahead.
Each fund has a set mix of investments in the underlying (G, F, S, C, I) TSP funds in ratios determined to be optimal for that time frame in terms of potential risk and reward. For example, the income fund is 20 percent stock (S, C, I) and 80 percent fixed (G, F) while the 2050 fund is just about exactly the opposite. The income fund always has been stable while every calendar quarter the profile of the others has shifted slightly away from the stock funds and toward the more conservative G and F funds as the projected withdrawal date grows nearer.
More on TSP Fund Choices at ask.FEDweek.com
The percentage of TSP investor money in those funds collectively has risen steadily since their launch in 2005 (there was a 2010 fund at the time, which in that year merged with the income fund while the 2050 fund began then). In 2006, it stood at 6 percent of account holdings. Now, it’s above 20 percent, around $120 billion.
In addition, more than a third of TSP participants now have some money in an L fund and nearly a fifth have all of their money in one.
But even an auto pilot needs to be reprogrammed now and then. That’s what the TSP decided to do recently after receiving a report from a consultant that made several arguments in favor of increasing the share of stocks in each L fund. One was that the TSP’s lifecycle funds were more conservative than comparable funds available for purchase through mutual fund families for the same dates. Another was that TSP investors overall are waiting until they are older to begin withdrawals.
That latter factor is largely linked to the increase in the average federal retirement age of recent years—both have increased by about two years to 63, on average. Those extra two years in effect give investors more time to build their accounts with potentially higher earnings from more emphasis on stocks. They also give them more time to recover from the potentially steeper drops they would experience in a downturn if having more of their money in stocks.
The result is that the TSP decided to increase the share of the income fund invested in the three stock funds collectively from 20 to 30 percent over 10 years starting in 2020. And effective immediately, the target-date funds will no longer grow more conservative over time. Instead they will be frozen until their investment profiles match what they would have been if they had been about 10 percent more weighted toward stocks from the outset.
There will be little impact on the investment mix of the 2020 fund, which is already near the profile of the income fund that it will merge with in that year. However, the 2030 fund is projected to remain frozen until 2024; the 2040 fund until 2028; and the 2050 fund until 2032. After those points, their quarterly readjustments will restart. Also, slightly more of each L fund’s stock holdings will be in the I fund beginning in January 2019.
Already, some TSP L fund investors are upset with the changes. They say that they liked the ratios as they were and don’t want to be exposed to the same level of stock market risk as they grow older. Others are saying that even after the changes, the funds will not be aggressive enough. Some in both groups are talking about taking some or all of their money out of the L funds and going back to more active investing.
That’s up to you, of course. You can choose whatever fund or funds you prefer for your existing account and, if you are still working, for new investments.
Just be aware that these new ratios were chosen by investment professionals inside and outside the TSP after thorough studies of past and projected market performance, risk and inflation, the relationship between the TSP and CSRS and FERS, and other factors. And maybe do a little thinking about why the L funds were created in the first place.
See also, the Pros and Cons of TSP Lifecycle Funds