TSP’s Lifecycle Funds: What You Need To Know

TSP Lifecycle Funds. Learn more about what TSP's Lifecycle funds can do for your retirement portfolio.

What you know about TSP’s Lifecycle Funds can set up your retirement game plan.

There are a lot of people who wonder what TSP’s Lifecycle Funds are, what they are supposed to do, and how they are supposed to invest in them. This article aims to answer some of these questions and provide a little clarity.

TSP Overview:

In order to understand more about TSP’s Lifecycle Funds, it’s best to understand a little more about TSP’s primary funds.TSP’s 5 primary mutual funds

  • G-Fund: Comprised of U.S. Treasuries
  • F-Fund: Index fund comprised of investment-grade U.S. corporate debt. Aims to track the Barclays Capital U.S. Aggregate Bond Index.
  • C-Fund: Index fund comprised of stocks from the top 500 U.S. Companies. Aims to track the S&P 500 Index.
  • S-Fund: Index fund comprised of stocks from U.S. companies not in the S&P 500. Aims to track the Dow Jones U.S. Completion Total Stock Market Index.
  • I-Fund: Index fund comprised of stocks from international companies. Aims to track the MSCI Europe, Australasia, & Far East (EAFE) Index.

There is a lot of information out there about TSP funds.  However, one important thing to understand is how diversification plays a role in building a solid portfolio.  Once you understand how TSP funds work, you can understand how Lifecycle funds work.

Watch this video for a quick Lifecycle Fund primer!

Lifecycle funds overview:

TSP’s Lifecycle funds are simply target-date funds that consist of different combinations of its G, F, C, S, & I Funds. A target-date fund is simply a fund that initially invests in growth assets.  Over time, this fund gradually shifts to more conservative investments until it reaches a predetermined date. For example, the L 2020 fund will gradually adjust its investment mix until the year 2020.  At this point, it will shift to the L-Income fund.  The L-Income fund is the most conservative of the L-funds, and most heavily invested in U.S. Treasuries. Currently, TSP provides the following funds (in order from most conservative to least): L-Income, L2020, L2030, L2040, and L2050.

Let’s compare the two extremes: L-Income & L2050. As its name indicates, L-Income is the fund of choice for people in retirement (actual retirement, not retiring from the military), who depend on a safe, predictable income from stable investments. Conversely, the L2050 fund is for people who don’t expect to use those investments until 2050 or beyond. As you would expect, L-Income contains a lot more of its investments in the G-fund than L2050, which has most of its investments in C, S, & I funds. The other funds fall somewhere in between, but vary based upon the investment horizon. The current breakdown (as of March 2015) is below, but can be found on the TSP Lifecycle Fund information page.

                         L-Income       2020                2030                2040                2050

G                            74%                    44                     29                       19                      10

F                               5                           5                      6                         6                        4

C                             12                        27                     34                      38                      42

S                               3                          8                      12                      16                       18

I                                5                         15                      19                      21                      25

As you can see, G & F funds (both bonds), make up almost 80% of L-Income, but only 14% of L2050. This allows L-Income to provide consistent income with a less risky portfolio. Conversely, stocks make up just 20% of L-Income, but 85% of L2050, which positions L2050 for long-term growth.

Lifecycle Fund Asset Allocation

Now that we know a little about Lifecycle Funds, let’s talk a little about the asset allocation. Asset allocation is simply the process of taking a certain number of investments (in this case the five TSP funds), and figuring out how much of your money to put into each. It’s a decision that everyone has to make, whether you want to or not. A lot of people decide to perform their own asset allocation, and choose which investments to put their money in. For TSP’s Lifecycle Funds, asset allocation is done based upon investment modeling by Mercer Investment Consulting, one of the world’s largest investment consulting firms. By choosing a Lifecycle fund, you are making a decision based upon analysis performed by a professional consultant.

Who Picks the Funds? 

Mercer Investment Consulting does, and they’re good at it.

If you’re trusting a decision based upon a consultant’s work, it might be worthwhile to learn a little about that consultant. According to Wikipedia, Mercer Investment Consulting is the world’s largest HR consulting firm, and has been around since 1937, when it started as the employee benefits department at Marsh & McLennan, Inc., the company who still owns it today. One of Mercer’s primary business lines is performing worldwide consulting work with companies & governments who administer retirement plans like TSP. Without going into more detail, let’s assume the folks at Mercer Investment Consulting know what they’re doing.

What is the Efficient Frontier?

Now that we’ve established who makes the decisions on your Lifecycle funds, we should look a little more into how they make those decisions. The TSP fact sheet explains the ‘efficient frontier,’ very well.  This is the basis of the Lifecycle fund asset allocation. Simply put, there is a risk/return relationship between any investment, or any combination of investments. The risk is measured in standard deviation, while the return is measured in annual percentage return—you can plot any investment on a graph that reflects these two measures.

The efficient frontier is a theory that all of the best possible investment combinations are plotted on a line in order from least to most risky. This line is known as the efficient frontier.  The Lifecycle Funds information page does a great job of explaining this with a graph on Page 2.

Lifecycle Funds and the Efficient Frontier. The efficient frontier simply states that there is a relationship between expected risk and expected return. The further out from you retirement you are, the further you can go on the efficient frontier. TSP's Lifecycle Funds are as close to the efficient frontier as you can reasonably expect.

In this case, we’re using TSP funds (and combinations of them), without respect to any other mutual fund, stock, or any other securities. Any investment that is above the efficient frontier line is not attainable.  For example, 0% standard deviation and 30% expected annual return is not attainable.  However, any investment below the line is less than what you should expect.  For example, 2% return at 5% standard deviation. As you can see, L-Income is much further to the left (indicating lower risk & lower expected return) than any of the target-date funds. As we get closer to the maturity of a target-date fund, you can expect that fund slide further to the left and approach the L-Income fund.

What happens when you start tinkering with other funds…you miss the point of having a Lifecycle Fund.

Now we get to the point. When you invest in TSP’s Lifecycle Funds, you are:

  1. Making a decision as to when you need this money
  2. Trusting the Mercer Investment Consulting asset allocation model

If you ‘set it & forget it,’ then you’re investing on the efficient frontier (or at least Mercer’s definition of it). Not only that, but the Lifecycle Fund automatically adjusts over time to lower the portfolio risk. If you invest in a Lifecycle Fund, then put a bunch of money in one of the other funds, then you’re probably going to screw up the asset allocation. This means you’ll either be taking too much risk for the return you expect to make, or you won’t be making as much money as you should expect for the risk you’re taking…you’re under the line. Not only that, but you’ll need to make regular adjustments to make sure your portfolio is properly balanced, which you don’t need to do with an Lifecycle Fund.

You might have money in other accounts, that you cannot put into TSP. There is nothing wrong with that. However, you should recognize that outside investments may alter your asset allocation within TSP. By sitting down with a fee-only financial planner, you can make sure that your asset allocation will meet your investment goals.

Bottom line

If you plan to use Lifecycle funds within TSP (outside investments notwithstanding), then use them exclusively. If you want to manage the funds yourself, please feel free to do so. However, don’t use Lifecycle funds, then make adjustments because you think you can add value. There is virtually zero chance of you being better off.

As always, this blog serves to answer your questions and address concerns.  If you want to stay on top of new articles, please feel free to subscribe or join the Military In Transition Facebook Group!  Also, you can reach me through my website or via email.  In the meanwhile, take charge of your life!

 

 

 

 

 

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About Forrest Baumhover

Forrest Baumhover is a Certified Financial Planner™ and tax professional. His firm, Westchase Financial Planning, focuses on the unique financial planning needs of servicemembers and families looking to separate or retire from active duty.If you’d like to learn more about Forrest or his services, please check out the About Forrest page at the top of this article.
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7 Responses to TSP’s Lifecycle Funds: What You Need To Know

  1. Pingback: Weekend Wrap-up: Military Personal Finance Articles You Should Read (2/26-3/3) | Military in Transition

  2. Kara says:

    What great info! We have a TSP and we love it so far (and hope not have to touch it!)

    • Forrest Baumhover says:

      Kara,

      Thank you very much! It’s great to hear you say that…I hope reading this comment will convince people that TSP is a good place to put their money.

      TSP is one of the best benefits of serving in the US government. It’s a great place for people to start if they want to save money and know they’re investing wisely, but don’t have the time to research their own investments (or don’t want to). It’s definitely a smart ‘first step!’

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  4. Bonnie says:

    Thanks for this article. My husband has a TSP. He will be 52 this year. We set this up some time ago and he is putting all of it in the L2030. Frankly, no matter how much I read, I really have a difficult time understanding finances but I knew this was pretty much a set it and forget it plan so that is why we did it. Additionally, we each have a Roth IRA. Your article set my mind at ease. We don’t tinker with it at all, mostly because as I said I don’t have a clue about playing with investments so I think the Lifecycle is a good choice for our family. Thank you! Bonnie

    • Hi Bonnie,

      Thank you very much for your comment! Hearing back from people who read my articles means a lot to me.

      Peace of mind is one of the most important things that you can achieve over your military (and post-military) life. Please let me know if there is anything I can do now, or in the future to help you out!

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