TSP Funds – One Is Right For You

As a natural progression in our Thrift Savings Plan (TSP) series, we have to talk about the various investment choices available.  Once a person has decided to invest in a TSP account, they have three decisions to make: how much to contribute, whether to invest in a Traditional or Roth account, and into which TSP funds they would like to invest. We’ve already covered contribution amounts and the differences between Traditional and Roth accounts, so I guess today I need to talk about the TSP funds.

This is a ridiculously huge post.  Go get a cup of coffee or a glass of water.

There are a variety of factors to consider when selecting a fund for your TSP investments. You need to consider your tolerance for risk, and also look at your entire financial picture. Every investment carries a level of potential gains, and a level of potential losses. The balance between those two is defined as its level of risk. Investments with little potential for loss, but also smaller potential for gain, are considered very safe. Investments with huge potential for gains, but also huge potential for loss, are considered very risky. Most investments fall somewhere in the middle, with some potential for loss and some potential for gain. A decision about investment risk is very personal. You have to consider whether you would be more comfortable with smaller, guaranteed returns or the possibility of making great gains or taking great losses. Investing should not make you stay up at night, worrying about your choices. A good investment plan has a balance of risk and safety that allows you to meet your financial goals and be happy with the decisions that you’ve made.

One thing that I think is seriously under-considered is how a TSP investment falls into your greater retirement plan. As a retirement savings tool, it is important to consider your other retirement savings tools when choosing how to invest your TSP money. Perhaps you expect to receive a military retirement and Social Security. A military retirement is an extremely safe, lifetime income that is adjusted for inflation. Therefore, you can assume more risk with your other retirement assets and still have balance in your overall retirement plan. On the other hand, if you are planning to leave the military after a few years and start your own business, you may want to invest your TSP contributions in more safe investments to offset the inherent risk in starting a business. For every situation, there is a balance of security and risk that makes sense and makes you feel comfortable.

The G Fund

The default fund is the G fund, the Government Securities Investment Fund. If you do not select a different fund for your contributions to purchase, you will purchase shares of the G fund. The G fund’s objective is to avoid risk and produce a rate of return that will outpace inflation. The G fund invests only in specific, short-term U.S. Treasury security that is only sold to the TSP. Earnings come from interest income on these securities. The G fund will never lose money but it is subject to inflation risk, which is the possibility that inflation could grow faster than the value of the G fund. This would decrease the purchasing power of the money invested in the G fund.

The Index TSP Funds

There are four index funds: the F Fund, the C Fund, the S Fund, and the I Fund. An index fund is an investment designed to match the performance of an index of a specific financial market. A stock market index is a tool for measuring the value of a portion of the stock market. Examples of stock indexes are the Dow Jones Industrial Average, the NASDAQ Composite, and the S&P 500. Each one measures the value of a certain sector of publicly traded stocks. Index funds are passively managed and do not change their holdings frequently. Each of the four funds offered by TSP attempts to replicate the index of a different sector of the stock market.

The F fund is the Fixed Income Index Investment Fund. Its objective is to match the performance of the Barclay’s Capital U.S. Aggregate Bond index, which represents the overall U.S. bond market. It includes U.S. Government bonds, mortgage-backed bonds, corporate bonds, and foreign government bonds. Money is earned through the interest paid on these bonds. The F fund may have larger growth than the G fund, but it is subject to more kinds of risk. The F fund’s value moves with the bond market and, therefore, is subject to market risk. This means that the value of your investment may move up or down. In addition, there is risk of default, meaning that the issuing company or government could fail to repay the money used to purchase the bonds. The F fund is also subject to inflation risk, where the growth of the fund is smaller than the growth of inflation. Lastly, F fund investments are subject to prepayment risk, which is where the purchased bonds are paid back earlier than expected and the fund is forced to reinvest at lower rates. The F fund is right for you if you want to invest in bonds.

The C fund is the Common Stock Index Investment Fund. Its objective is to match the performance of the Standard and Poor’s 500 (S&P 500) index, which is made up of stocks of 500 medium-sized and large-sized U.S. companies. Money is earned through the growth in value of the stocks, and also through dividends issued by the stocks. The C fund has the potential for larger gains than the G or F fund, but it is subject to market risk. Market risk is the rising and falling of the value of individual stocks inside the fund. C fund investments are also subject to inflation risk. The C fund is right for you if you want to invest in large, U.S. companies. The S fund is the Small Cap Stock Index Investment Fund. Its objective is to match the performance of the Dow Jones U.S. Completion Total Stock Market index, which is made up of stocks of small-sized to medium-sized U.S. companies that are not included in the Standard and Poor’s 500. Money is earned through the growth in value of the stocks, and also through dividends issued by the stocks. The F fund has the potential for larger gains than the G or F funds, but also subject to market risk and inflation risk. The S fund is right for you if you want to invest in smaller, U.S. Companies.

The I fund is the International Stock Index Investment Fund. Its objective is to match the performance of Morgan Stanley Capital’s International EAFE (Europe, Australasia, and Far East) index, which is made up of stocks from around the world. Money is earned through the growth in value of the stocks, dividends issued by the stocks, and changes in currency valuation. The I fund has the potential for larger gains than the G or F funds, but is also subject to market risk, inflation risk, and currency risk. Currency risk is the potential for losses due to the rising and falling of the value of the US dollar versus the currency in which the stock is traded. The I fund is right for you if you want to invest in international companies.

The Lifecycle TSP Funds

Traditional investment wisdom suggests that you should invest in more aggressive stocks and bonds earlier in your investment life, and gradually move towards more safe investments as you get closer to retirement. In order to make the process simple for investors who don’t want to make a lot of decisions for themselves, the TSP created Lifecycle funds (L funds). These funds use pre-determined investment mixes designed to meet specific investment objectives based upon the target retirement date. L funds invest in the G, F, C, S, and I funds. The funds are automatically rebalanced as the L fund moves closer to its end date. The L funds are subject to all the same risks as the individual funds in which it is invested. L funds provide a simple, diversified portfolio that requires little effort on your part.

At this time, there are four targeted L funds available, and also a L Income fund that holds money in accounts that are already making monthly distributions to their owners. The Lifecycle funds available now include:

• L 2050, for people who plan to retire in 2045 or later,

• L 2040, for people who plan to retire between 2035 and 2045,

• L 2030, for people who plan to retire between 2025 and 2035,

• L 2020, for people who plan to retire between 2015 and 2025.

You are not required to choose just one L fund, and can choose a portion of two if you think that best represents your desired outcomes. The choice of TSP fund is very individual and should include a comprehensive look at your entire retirement income portfolio. However, don’t let analysis paralysis mean that you don’t start contributing.  If you have to, just pick one and get started.  You can always change your mind later, and making adjustments is quick and easy online.

For the rest of the TSP series, see:

Day One: Everything You Ever Wanted To Know About TSP

Day Two: Roth or Traditional Thrift Savings Plan Accounts

Day Three: How Much Should I Contribute?

Day Four: TSP Funds:  One Is Right For You

Day Five: Taking Money Out Of Your Thrift Savings Plan Account