Saturday, May 6, 2017

Dear Thrift Savings Plan: Are You Shortchanging U.S. Government Workers?

An Open Message to the U.S. Government's Thrift Savings Plan:

There is a great deal to be admired about the U.S. Government's Thrift Savings Plan (TSP). Its low fees and costs (including low turnover, and hence low transaction costs, within the funds). It's L funds (Lifecycle Funds), that make investing easier for government employees. The stable value feature of the G fund and (in a fairly low interest rate environment) its attractive yield, given the lack of interest rate risk.

Yet, upon closer scrutiny, the TSP only has 5 investment options (plus the Lifestyle Funds):

  • G Fund: Government securities (specially issued to the TSP)
  • F Fund: Government, corporate, and mortgage-backed bonds
  • C Fund: Stocks of large and medium-sized U.S. companies
  • S Fund: Stocks of small to medium-sized U.S. companies (not included in the C Fund)
  • I Fund: International stocks of more than 20 developed countries
And, here's the rub. Over the past 25 years academic research has revealed "factors" that can be utilized to gain additional risk exposures, while also leading to high probabilities (over 10-20 year periods) of additional returns. While literally hundreds of factors have been discovered, only a handful have both withstood academic scrutiny and are "investable" at a fairly low cost. Examples of these factors include the value risk premium, the small cap risk premium (with newer research indicating its concentration among either micro cap stocks or small cap value stocks), and the profitability factor. (Others exist, as well.)

Yet, the Thrift Savings Plan has no funds that take advantage of these factors and this academic research. The result? Underperformance of a portfolio that uses only the TSP funds, relative to what could be achieved, is likely to occur by 1% to 2% a year (or greater) over most 10-20 year periods of time. Given the effects of compounding, this is likely to translate to 25% to 50% (or greater) lesser accumulations in their retirement accounts, at least for those government employees who invest fairly aggressive in equities (as they should) starting at age 25 and continuing to age 45. (Note that saving and investing wisely, early on in one's career, is key to building the foundations for a successful retirement and "financial freedom.")

Nor do the Lifestyle Funds stack factor exposures with the equity premium, while lowering allocations to fixed income - which portfolio construction has a high likelihood of achieving the desired levels of returns but with much less overall risk exposure.

So, I appeal to you, on behalf of my friends who work for the U.S. government and who participate in the TSP. Please add:

  • A multifactor total U.S. stock market fund with tilts toward value, small cap, and profitability.
  • A multifactor total foreign markets fund with the same tilt, and providing exposure to both foreign developed markets and foreign emerging markets.
  • The use of such multifactor funds within your LifeStyle Funds (or some new Lifestyle Funds).
  • For employees who desire to best integrate their TSP funds with their outside investments, additional individual funds should be offered in these research-favored asset classes:
    • U.S. large/mid cap value stocks;
    • U.S. small cap value stocks;
    • International developed markets large/mid cap value stocks;
    • International developed markets small cap value stocks; and
    • Emerging markets value stocks.
Our government workers endure many sacrifices to serve the public. Please, TSP, take your stewardship of these workers' hard-earned savings to the next level, to better serve them.

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