Sometimes I wish I was still in the military. I miss the camaraderie, doing something different all the time, and the chance of adrenaline driven action. Most of all, I wish I had access to the Thrift Savings Plan.
The Thrift Savings Plan (TSP) became available to the military in late 2001. It’s a 401(k) style retirement account where federal employees and military personnel can contribute and invest in several different index funds managed by BlackRock. Members of the military do not receive any matching contributions, but some federal agencies provide them for their employees. Members have the same maximum contributions as 401(k) accounts, which is $17,500 for 2013.
It’s very impressive that the government chose to only offer index funds, which are proven to beat the performance of actively managed funds 70% – 80% of the time. More private employers who offer 401(k)’s should take the cue and implement low expense index funds in their pool of investment options. Many still do not offer index funds or have a poor selection.
Index Funds For The Long Run
The idea is that there is a lot of risk in investing. By indexing, you accept a market return for the diversification of assets and a standardized investing strategy. Index funds make it easy to match target allocations without constantly trading or re-balancing. Unless the index changes, the investments you hold remain steady. You know what you’re invested in.
With active funds, the manager has discretion (up to the limits of the fund charter) on how assets are invested. You may not be invested in the holdings that you think you are, and may be overweight in some. Not all actively traded mutual funds report their trades immediately. That means you won’t know what you’re really invested in at all times. Your holdings may not match your asset allocation.
When investing for the long-run (i.e. retirement), it’s a good idea to be invested in index funds. You don’t have to worry if you’ve picked a good fund manager, deal with changes in management, consider portfolio turnover, or any of the other factors involved with investing. If you are investing for the long run, the funds you have in your tax deferred accounts will have the greatest chance to grow in index funds.
The problem with index funds is that they don’t always match the performance of their index. This directly relates to the expenses, or fees that the mutual fund charges to operate the fund. That’s why it’s important to choose low cost mutual fund providers like Vanguard and Fidelity when you can. The lower the expenses, the closer the fund gets to matching the index.
Individual/Index Funds Annual Returns (past 5 yrs)
| Year | G Fund | F Fund | U.S. Agg. Bond Index | C Fund | S&P 500 Index | S Fund | DJ U.S. Completion TSM Index | I Fund | EAFE Index |
|---|---|---|---|---|---|---|---|---|---|
| 2008 | 3.75% | 5.45% | 5.24% | (36.99%) | (37.00%) | (38.32%) | (39.03%) | (42.43%) | (43.38%) |
| 2009 | 2.97% | 5.99% | 5.93% | 26.68% | 26.46% | 34.85% | 37.43% | 30.04% | 31.78% |
| 2010 | 2.81% | 6.71% | 6.54% | 15.06% | 15.06% | 29.06% | 28.62% | 7.94% | 7.75% |
| 2011 | 2.45% | 7.89% | 7.84% | 2.11% | 2.11% | (3.38%) | (3.76%) | (11.81%) | (12.14%) |
| 2012 | 1.74% | 4.29% | 4.22% | 16.07% | 16.00% | 18.57% | 17.89% | 18.62% | 17.32% |
Percentages in ( ) are in negative.
TSP Index Funds Are A Superior Investment
Here is where BlackRock emerges as a winner. BlackRock charges a super low expense ratio of 0.024% – 0.027% to manage the TSP funds. Compared to Vanguard Admiral Class shares and Fidelity Spartan Advantage shares, the cost of investing in the TSP clearly rivals that of anything available to the regular public.
But that’s just the start of where the TSP excels. In 2012, The C Fund (mirrors the S&P 500) and the F Fund (matches the Barclays Capital U.S. Aggregate Bond Index) outperformed the index by 0.07%. The extended and international stock funds also beat their benchmark indices. How did they do that?
Managers of index mutual funds and ETF’s earn money to run their operation and pay salaries through their administrative expenses, known as expense ratios. But they also earn extra money by lending their holdings to investors, mostly hedge funds, who bet on performance by borrowing shares of stocks and bonds. BlackRock doesn’t disclose the official amount of money they make from this activity, but experts suggest that they pay about 80% of lending income back into the TSP funds. That income, even if it is a small portion of the total earnings, is a great way for the company to earn additional cash on idle assets and line the pockets of investors.
This post is getting a little long, so I’ll write more about the TSP later. For now, if you have access to the TSP, I highly urge you to contribute as much as possible. Junior enlisted personnel should be taking full advantage of the Roth TSP option since they pay little to no taxes due to their low incomes.
Do you participate in the TSP? What has your experience been like?
Talk to me, Goose.