The Federal Retirement Thrift Investment Board (FRTIB) has released a new series of "lifecycle funds", or (L Funds), as an investment "alternative" for TSP investors.
Rather than offering the benefit of an additional index fund investment alternative (the approach taken by most professional 401k fund administrators), TSP investors are now being encouraged to participate in the new "lifecycle fund" series that carries an essentially age-targeted asset mix based on the date you expect to begin drawing down your TSP account (assuming that date can indeed be "fixed"). That mix of TSP stock and bond funds would then change, or be automatically "balanced" as you approach that date.
See the record for TSP Pilot's performance enhanced, timed L Funds, that increase returns while dramatically reducing the market risk of being invested in those funds.
While the concept is generally sound, the L Funds are nothing more than buckets of existing TSP funds mixed and packaged according to risk. They do not provide a new dimension for return, and they do not allow market risk to be matched to market direction, as does the TSP Pilot Portfolio.
The "lifecycle funds" are offered by the year in which you "expect" to begin to draw down your account. For those about to retire TSP is offering the "Income Fund." Four other funds stretch out from 2020 to 2050. There will be a gradual balancing and rotation of the funds with time.
There is also a popular misconception that TSP will guarantee your initial investment if you hold an L Fund all the way to its target date. All L Funds will vary in concert along with their underlying markets (in varying degrees) and may well loose value by the time their target dates arrive.
Remember, there is NO guarantee that you as a TSP account holder will get all your money back even if you succeed in holding on to your L fund al the way to its target date.
Why the L Funds
The TSP folks have noticed that an uncomfortably high percentage of its investors seem to remain "locked" within the safe harbor of its "G" fund.
In an effort to move more TSP investors into the TSP stock funds, where the long-term returns are higher, the TSP folks will be using the new "lifecycle fund" series to make artificially simple a series of very complex investment concepts. The problem is that those simplistic new funds could prove to be a very costly compromise in terms of risk/reward for those who don't happen to fit their "cookie cutter" mold.
The Conceptual Problems with the L FUNDS
Unfortunately, the TSP L Funds offer TSP Pilot subscribers no advantage whatsoever. The L Funds are essentially static baskets of the existing TSP stock and bond funds that offer virtually no protection against sharp market declines. Time horizon is only one lone ingredient in establishing an accurate personal risk profile for investors, but for the TSP L Funds, time horizon is simplistically the only factor being considered. Additionally, any simple "buy-and-hold" strategy in the new L Funds will leave you unnecessarily stuck and exposed during rapidly declining markets.
The intellectual premise for the L Funds is sound. The problem lies in the practical application of the underlying principle. Generally, you should take more aggressive stock fund positions in your early working years and decrease that exposure gradually as you approach retirement. It is true that in your early working years you can afford to take a riskier investment posture to meet your retirement goals as you would have more years to recover from bear market losses.
So where is the problem? The problem is that you would need the emotional fortitude of a crocodile to sit patiently through the intervening, and often devastating, bear markets that are likely to ensue sometime in the future. Most, unfortunately, would throw in the towel and leave the "Lifecycle Funds" for a safer harbor long before the target years.
Success with a "Lifecycle Fund" requires the iron-willed dedication to remain with that fund through periods of extremely stormy weather. In reality very few would be able to summon the long- term fortitude to remain within the program--and leaving the fund prematurely would mean failure.
The argument that investors should take, and indefinitely hold, a fixed position in a pre-set portfolio of "lifecycle" or "age-adjusted" TSP funds just can not stand up against the results of an effectively timed, dynamically managed portfolio mix of those same funds such as that provided by the loss limiting TSP Pilot Portfolios.
While this may be somewhat useful for those TSP investors who happen fit the specific age/risk profile provided by the fund's specific, pre-set allocations, it is an unfortunate cookie-cutter, or one-size-fits all approach intended to artificially simplify what should always be a very complex dynamic asset allocation stock fund investment process.
Just because you're younger doesn't mean it'll be any easier to lose your hard-earned TSP contributions to any future sharp and protracted bear market losses in the L Funds.
The TSP folks often argue against "chasing performance" when supporting their new L Funds. While we essentially agree with that in principle, it should be understood that TSP Pilot services do NOT fall within their "chasing performance" category.
Most amateur investors will react to rising or falling stock prices without having a researched, professionally structured and disciplined investment approach. When stock fund prices jerk frenetically around from week to week, amateurs will often make a series of short-term emotional and "reactive" allocation and balance adjustments for their TSP accounts. Those irrational "chasing" adjustments are almost always money losers and also increase administrative costs for the TSP.
TSP Pilot only recommends well-researched and structured intermediate to long-term allocation and balance adjustments. We do not, and will not "chase performance."
The L Funds Under-Allocate
In a recent article in major financial weekly a leading portfolio manager of 401k Plans maintains that the L Funds are too conservative in their investment allocations. At all target age levels L Funds have a tendency to under invest in stocks and over invest in bonds and cash.
As workers live longer and longer past retirement, there will need to be increasing levels of asset growth to fund those future years of advancing living costs. The TSP L Fund stock allocations will likely need to be increased over current scheduled levels to fund the necessary asset growth required to support increasing cash draw-downs for at least ten years or more post retirement. The current TSP L Funds allocations do not yet reflect the reality of increasing port-retirement costs.
Additionally, the pre-determined L Fund allocation formulas for the various target "age groups" were determined purely by estimates and approximations--certainly an inexact science at best. The bottom line is that the TSP L Funds are a very, very new and unproven area of the market. The allocation strategies for the L Funds are likely to change rather dramatically over time as the new lifecycle concept matures.
Just Another Buy-and-Hold Option
Another problem with the new "lifecycle funds" is that they AUTOMATICALLY assume that if you are young, and have a good number of years to go before retirement, you should AUTOMATICALLY be willing to assume more market risk, whether you want to assume that added risk or not, by being more heavily invested in the TSP stock funds. That risk is pre-set and fixed at an arbitrary level for the L Funds by the TSP folks--regardless of your individual needs or personal risk tolerance profile.
The converse is also true. If you are older and closer to making withdrawals from your account the TSP assumes that you MUST therefore be more risk averse. The TSP would then have you invested in a more risk averse "lifecycle" portfolio weighted towards the defensive bond funds. Again, your risk level is pre-set and fixed for you at some arbitrary level by the TSP regardless of your own personal risk profile or level of risk tolerance.
The new TSP "lifecycle funds" provide just another more "sophisticated" buy-and-hold option with the feature of pre-set fund allocation "risk adjustments" to be made over time as you age.
Essentially, the Federal Retirement Thrift Investment Board should not be "assigning" you an "appropriate" level of risk just based on your age or years to draw-down.
Most importantly, the new L Fund series will NOT provide you, the TSP Pilot subscriber, with any new additional flexibility, diversification or profit opportunity. Buying and holding the L Funds would, however, impose a new and unnecessary limitation on your TSP Pilot retirement options if chosen.
Just because you may be 30 years from retirement doesn't mean you could, or should, sit calmly and idly by while your account falls 30% to 50% in value during another protracted bear market like the one in 2000-2003 or in 1973-75 after which it took 6 l/2 years to fully recover!
Regardless of your age or your years to retirement, losing money while sitting in stock funds during protracted bear markets destroys compliance and confidence and unnecessarily erodes account values.
Even if you thought you'd be willing to sit through a decline like that if and when it occurred, when it actually happens in real time, with your real money on the line in your own personal retirement account, you would more than likely not be able to summon the emotional fortitude and courage to stomach the financial damage. A premature pulling out of a lifestyle target fund would likely defeat the very purpose of that fund in the first place.
Remember, for 50% loss you take you will need a 100% future return just to get back to break even! Why voluntarily give up five years worth of your hard-earned contributions while you sit and watch your account fall out of bed!
Rather than introducing a "lifecycle fund" series, perhaps a more appropriate offering would have been a new, targeted market sector index fund such as a Real Estate Investment Trust (REIT) fund or a mid-cap value fund. Such new offerings would have provided a true added level of investment diversification and profit opportunity for TSP Pilot subscribers. The problem is that while providing a major benefit to you, the individual investor, adding such new targeted sector index funds would cost the TSP Plan administrative money and add "confusion" to the investment process for inexperienced investors thus making it a "no-no."
The TSP folks like to advertise that their new L Funds will put your TSP account on “cruise control." Unfortunately, a hands-off driving approach to investing will usually wind up totaling your investment car when bear markets strike.
The bottom line is that risk assessment is a far too complex an art and too distinctly personal a factor to be inflexibly assigned and fixed for you based on some arbitrary assessments and assumptions.
Unlike the TSP Pilot Portfolios, the new "lifecycle fund" offerings from the TSP will NOT be market-timed funds since the FRTIB is not an investment advisor. These new funds will not offer the TSP Pilot subscriber any new opportunity to improve investment returns or limit market exposure risk.
However, if you your personal risk tolerance miraculously matches your years to retirement, AND you have the emotional fortitude of a crocodile and are determined to be a buy-and-hold investor through both feast and famine, then the new "lifecycle funds" "might" be for you.
While we don't recommend these new funds for current TSP Pilot subscribers, we will be carrying a basic long-term buy/sell timing signal for each of those new L Funds. The new "all in/all out" signals will appear on our Current Advisory Page and will be based on a series of market indicators already matched to that mission.
TSP Pilot's long-term timing recommendations for the L Funds would at least keep you from suffering the financial damage another bear market would cause while keeping your account sound for taking advantage of the next bull market to come.
While the new "lifecycle funds" will not be, and should not be, considered a "solution" for all TSP investors, they apparently will be heavily marketed to all TSP investors--regardless of your investment experience or personal risk tolerance.
In private industry only about 12% of investors opt to completely convert to this "lifecycle" approach when offered. Some investors may find the new "Lifecycle" funds a convenience. Others will find them a costly and inflexible choice. At a minimum the Thrift Savings Board should respect your varying levels of investment sophistication and preserve your freedom of choice--especially to move between the TSP funds at your own will and at your own timing to preserve and increase your own retirement money.
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