Government TSP: What Everyone Ought To Know About TSP Lifecycle Funds - 2014 Update - YouTube

Welcome to the 2014 update of what Everyone Ought To Know About TSP Lifecycle Funds.

My name is Dieter Scherer, I’m a fee-only financial planner and founder of

RealizeYourRetirement.com. Today we are going to cover how TSP Lifecycle Funds work, the

advantages of TSP Lifecycle Funds and the disadvantages of TSP Lifecycle Funds.

So, without further ado, let’s jump into how the TSP Lifecycle funds work.

Lifecycle funds utilize what is called a “glide path”.

A glide path is a formula that slowly changes the allocation of the lifecycle fund over time.

Generally the allocation changes slowly from a more equal mix of stocks and bonds to a portfolio that is

primarily comprised of bonds.

When you look at a lifecycle fund, for example the L-2020 fund, the 2020 indicates

the end target date of the fund. So, by 2020 the allocation will transition from its current

allocation to its ultimate more conservative allocation.

To show you how the lifecycle funds work, I’ve taken screenshots from the TSP

website, which show the allocation of the L-2020 Lifecycle fund through time.

When the fund was first established in 2005, its allocation was 35% bonds, and 65% stocks.

By July of 2014 the bond allocation had increased to 48.5% and the

stock allocation had decreased to 51.5% . And finally by its end date in July of 2020, the

allocation to bonds will increase to 80% and the allocation to stocks will decrease to 20%.

Each quarter the allocation moves from the stock dominated portfolio on

the left to the bond dominate portfolio on the right.

As you can see, over time this leads to an allocation that is predominantly bonds. Specifically, the G fund is 74%

of the portfolio by retirement. As a quick note before we move on, if you’d

like to know more about the various funds in the TSP, I also have a breakdown video of

the characteristics of each fund. A link will be provided at the end of this video.

Once the lifecycle fund has reached its target date, all investments in the fund are

rolled over to the L-Income fund, which simply maintains the allocation that the

lifecycle funds reach at their target date. The L-Income fund does not change its allocation

over time and maintains the predominantly bond allocation you see on the right.

Now that we’ve covered how the funds work, let’s dive into the advantages and disadvantages of the Lifecycle Funds.

Although I am not a fan of Lifecycle funds for the reasons that will follow in a moment, there are

several advantages to Lifecycle funds that cannot be overlooked.

First of all the Lifecycle funds are inexpensive. The funds themselves are simply

allocation vehicles that allocate your money across the five funds in the TSP. The

lifecycle funds do not have any fees beyond the fees that are assessed by the TSP funds.

Lifecycle funds are also low maintenance. Once you invest in the lifecycle funds

you are on autopilot. You do not have to make any changes to the allocation, your money will

be invested according to the glide path we spoke about earlier.

The set-it-and-forget-it strategy of the Lifecycle Fund does not require you to have any working

knowledge of investments. You simply determine when you are likely to retire and choose the

Lifecycle fund that is closest to your retirement date.

If you are intimidated by investing and would have left the your investments in the G Fund, which is the default investment

for all money contributed to the TSP, the Lifecycle funds do offer better diversification

than doing nothing. At least in the Lifecycle funds you will have some exposure to both US

and international stocks, as well as longer term bonds, rather than simply the G fund's that are

special issue short term treasuries.

Now, on to the disadvantages. Home country bias is when an investor allocates

a disproportionate amount of their money into their home country versus the size of

their country in light of the global market portfolio.

The TSP Lifecycle Funds demonstrate

considerable home country bias. The TSP generally encourages passive investing

and passive managers generally weight markets by their size in relation to the global market capitalization.

However, US Stock markets comprise around 35% of the global market capitalization.

However, if we look at the allocation of equities between the US and

foreign stocks, we come to see that US stocks comprise over 70% of the allocation of the entire equity portion of the portfolio.

We see this increase even further after once the funds shift over to

the L-Income allocation, where 75% of the equity portion of the portfolio is allocated to US stocks.

This means that the Lifecycle fund managers are making an active bet on the US

stock markets over a long time period. However, this active bet has little justification.

I say this because allocations do not take market valuations into account

When we measure US stock markets by utilizing market valuation techniques, we see that US stocks are among some of the

most expensive in the world.

This causes the US stock market’s long term returns to likely be inferior

to that of many foreign markets, whose overall valuations and prices are much cheaper for their earnings and growth potential.

Additionally, the Lifecycle funds simply follow their glide paths and do not even make simple changes based on the economic environment.

For example, for the bond allocation of the portfolio, in a falling interest rate environment it would behoove you to invest

in a falling interest rate environment it would behoove you to invest more in the F Fund

to make advantage of the capital gains market particapation would provide as interest rates decrease.

In a rising interest rate environment it would be better to invest in the non-marketable G fund,

wherein there would not be any losses from market movements and you would receive steadily increasing interest rates

within the fund.

Another example that would be beneficial for investors would be to buy more stocks and sell bonds during

recessions and the beginning of market recoveries when stocks are on sale. You could then reduce those

allocations back toward more moderate values as the market recovers.

One of the biggest problems with the TSP Lifecycle funds is their overly conservative

portfolios. This can hamper your portfolio’s ability to survive throughout your

retirement. Longevity is the chance that you outlive your money because your rate of

withdrawals outpace the rate your portfolio grows. You then outlive your portfolio’s ability

to fund your lifestyle. Longevity risk is as real as market risk.

Now if we look at the allocations, specifically the G-Fund's allocation, it's 74%

of your portfolio at the end of the glide path, when you retire.

The 10 Year return on the G-Fund has been an anemic 3.39%. Which is below even the conservative safe withdrawal rate of 4% of your

portfolio.While this may improve as

interest rates rise, it’s difficult to support a retirement income with such a large amount invested in short term bonds.

You see, when you have, 74% in the G-Fund and

6% in the F-Fund, there’s only a 20% allocation to stocks during retirement,

which as I mentioned, significantly decreases the potential returns and survivability of the portfolio.

In fact, Michael Kitces, a well-known financial planning researcher and practitioner, penned an interesting piece that determines utilizing a

“Reverse Glide Path” can be more beneficial through time.

In a reverse glide path retirees allocate a portion of their portfolios to stocks and another to bonds and cash.

During recessions they do not sell stocks to fund their withdrawals and instead draw

down the cash and bond portions of their portfolio. They do not replenish the cash portion of

the account until it is depleted, leading to a scenario where the equity portion of the

account, as it grows back, actually begins to dominate the allocation for the portfolio.

This strategy, which is in direct opposition to the glidepath strategy of Lifecycle funds,

can actually be more beneficial in mitigating longevity risk for retirees than the currently used Glide Path of the Lifecycle Funds.

And finally, Lifecycle Funds only focus on one aspect of your financial picture, when you will retire.

However, your date of retirement is only one part of the picture.

Proper investment management takes several factors into account:

Your income and growth needs

Your ability to deal with losses in your portfolio The current economic climate

The valuation of the markets The allocation of your other investment accounts

Alternative sources of income And finally, your time horizon, which is the time period over which you invest.

The administrators of the TSP like to keep things simple, so they use the time horizon as

the sole customization criteria for the TSP. It allows them to serve a broad swathe of people and keeps it simple.

But these are things you, if you are self- directed, or your financial advisor

should take into account. Unfortunately, even if you don’t use the Lifecycle

funds, there are limitations with how many of these aspects you can address with the TSP’s

limited offering of 5 funds. Therefore, if your primary investment account is

the TSP, it’s important to use an IRA or brokerage account to increase your diversification by

having access to more investment options. If you allocate across the accounts as

if they were one account, you can use the 5 fund options where they fit best within the overall diversification amongst your accounts.

You’d also be able to better manage specific investments based on specific goals.

Now let’s quickly go over what we’ve covered today.

Lifecycle funds: Are inexpensive and do

not have any expenses beyond the underlying fund expenses.

They’re better than just having all of your money invested in the G-Fund, which is the default allocation of the TSP

However, while they are better than a 100% allocation to short term bonds, Lifecycle

funds may not offer a retiree the optimal allocation for their retirement

This is due to several factors including being overly conservative with outsized allocations to bonds,

This is due to several factors including being overly conservative with outsized allocations to bonds,

the funds have significant home country bias when they do invest in stocks,

Lifecycle funds only focus on one of the factors that you should take into account when designing your

retirement portfolio, And finally structuring a portfolio using

a Reverse Glide Path, which is almost the exact opposite to the TSP’s allocation, can actually

increase your retirement portfolio’s chances of survival and growth.

I hope you’ve enjoyed my video about TSP Lifecycle funds.

I hope you’ve enjoyed my video about TSP Lifecycle funds.

To learn more about intelligent investing strategies and how to plan for your retirement, go to RealizeYourRetirement.com and

sign up for my free course Retirement Planning Academy.

In there you’ll learn how to maximize your social security, how fixed indexed and variable annuities actually work, how to

properly diversify your portfolio, and how strategies like value investing and

tactical asset allocation can help your portfolio take smarter risks when investing.

If you are interested in learning more about the TSP check out these

two videos below. The video on the left details the characteristics of each fund in

the TSP and the video on the right goes into the advantages and disadvantages of the TSP

Thanks for watching, if you’ve found these videos helpful let me know by liking

this on Youtube or Facebook and sharing it with others who it could help. Thanks a lot for watching and have a great day!