Nearly five million people have some or all of their retirement savings in the U.S. government’s Thrift Savings Plan (TSP), and many of them probably aren’t managing it to its full potential benefit.
The TSP is the government’s equivalent of a 401(k) plan. Money is contributed automatically every pay period and invested in one or more of three basic investment options.
For more than 15 years I’ve been recommending combinations of TSP investment choices for conservative, moderate and aggressive investors.
Unlike most 401(k) and similar plans, the TSP is simple, with a very limited range of investment choices. This eliminates many opportunities for mistakes. But it also eliminates a few important asset classes that can add a lot of long-term value to people who are saving for retirement.
If you’re participating in the TSP and want to maximize your long-term return, read on.
The TSP offers target-retirement date funds for those who want the simplicity of choices already made for them and an automatic evolution toward a more conservative stance as an investor ages.
For those who want to make their own choices, the TSP offers five options:
•The “C” fund is a clone of the S&P 500 index
•The “S” fund is an index of all U.S. stocks that aren’t in the S&P 500. That means midcap and small-cap stocks.
•The “I” fund is a clone of the MSCI EAFE Index
of international stocks in 21 developed markets excluding the United States and Canada.
•The “F” fund is an index of world-wide bonds, both government and corporate.
•The “G” fund is invested in short-term U.S. Treasury securities with no exposure to the risk of the bond or stock market.
These five choices provide exposure to large-cap and small-cap U.S. stocks, international stocks and of course the broad bond market and a risk-free, cash-like option.
In my view, the most glaring weakness of these choices is the lack of any value option. Over many decades, value stocks have consistently provided superior long-term returns to the growth stocks that tend to dominate the “C” and “S” funds in the TSP.
In this article, I’ll go over my general TSP recommendations and then suggest two optional variations that I expect will enhance long-term returns.
My recommendations fall into three groups: conservative, moderate, and aggressive. For each category of investor, I recommend splitting the equity part of the portfolio the same way: 50% in “S” and 25% each in “C” and “I.”
The differences between the three groups (conservative, moderate, aggressive) involve how much, if any, of the portfolio should be in the “F” and “G” funds. Not exposed to the risk of the stock market, in other words.
The conservative recommendations call for only 40% in equities; moderate recommendations call for 60% equities; and aggressive recommendations call for 100% equities.
In general, young investors should be more aggressive, and older ones should be more conservative, although that is a generalization.
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Higher returns within the TSP
If you’re choosing from the five TSP options, you may achieve higher long-term returns by emphasizing the “S” fund. That would tilt the portfolio toward small-cap and midcap stocks, which over long time periods have outperformed large-cap stocks like those in the “C” and “I” funds.
For example, aggressive investors (this may include many people in their 20s and 30s) could put 70% or 80% (for that matter, up to 100%) of their portfolios in the “S” fund.
For conservative and moderate investors, a simple way to increase expected returns is to own more equity funds. For example, a moderate investor could increase the combined equity stake from 60% to 70%, or even more.
For each additional 10% you hold in equities, your long-term expected return goes up 0.5% annually. That doesn’t seem like much, but over a few decades it can make a huge difference in the amount of money you have at retirement.
If you’re in a TSP target-date fund, you might consider reallocating 10% to 40% of your regular contribution to go into the “S” fund. Here’s an article that tells what a change like that could do for you.
Higher returns outside the TSP
If you read the article referenced above, you learned that even a modest allocation to value stocks, and especially small-cap value stocks, can produce a very significant boost in long-term returns.
Even though the TSP doesn’t offer value options, you can supplement your government retirement plan with an outside account. Your best bet is a Roth IRA, to which you can contribute up to $5,500 a year ($6,500 if you’re over 50).
The best way to use such an account to supplement your TSP is to invest your entire IRA in large-cap value stocks, small-cap value stocks and emerging markets stocks.
If you have only a relatively small amount available for this purpose, you’ll likely get the most long-term bang for your buck if you just add small-cap value, either in an ETF or a low-cost index fund.
For more retirement tips, check out my podcast, “22 ways to make more on your 401(k) or IRA.”
Richard Buck contributed to this article.