If your TSP is in an L fund, do not set it and forget it

Guest:	Art Stein
Title:	Arthur Stein Financial
Summary:	Many federal employees with long time horizons to retirement automatically put their TSP contributions into an "L" fund. That will mature about the same time as they plan to retire. But the "set it and forget it" approach can actually cost you purchasing power.

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Interview transcript:

Art Stein The L Funds are the most recent edition of the TSP, although they’ve been around certainly for way more than 10 years. But they are not a new investment sector. They are a new way to invest in the five traditional funds. And the five original funds are the G, F, C, S and I, which are invested in various bonds and stock markets. What the L Funds do is when they’re first introduced, they have a very high percentage allocation to the stock funds, very low percentage allocation to the bond funds, but that allocation changes over time and eventually becomes very conservative for almost all the monies in the bond funds. And that change is called the glide path. Now all the L Funds except one have a year associated with their names. So there’s the 2030 fund, the 2035 fund, all the way up to the 2070, and at the end of this month there’s going to be the 2075 fund. And what that indicates, that’s the year when that L-fund is retired and all the money goes into what’s called the L Income Fund, where the allocation is currently 24% stocks and 76% bonds. So it becomes very conservative. And supposedly, this is a good idea because that very conservative portfolio, and actually the 76% bonds is almost all in the G fund, has very low volatility. And supposedly volatility is the biggest risk. Well, that’s not true. Volatility is one investment risk. The biggest risk for long-term investors is taxes and inflation reducing the purchasing power of an investment. The reason that stocks have historically been a good investment is because they had a high enough rate of return so that after taxes and inflations, they would still increase purchasing power. And the bond funds and bank accounts too, the rate of returns is too low to do that. So when them money comes out, the purchasing power is down, and of course, with FERS employees, their annuity loses purchasing power any time inflation is more than 2%. So if their TSP fund’s losing purchasing power and their annuities are losing purchasing power, that’s a tough way to fund a retirement. So what I recommend is, don’t treat the L Funds as a “set it and forget it” type of investment. You need to pay attention, and when you’re 10 to 15 years away from your L Fund maturing, you need to take a look at that and maybe get out of the L Funds and, you know, choose an allocation between the stock funds and the bond funds instead of letting the L Fund do it for you.

Terry Gerton So that’s a lot of advice in one short statement, but I want to break it apart a little bit and go back through the pieces of it. So if I’m a young federal employee now, and I want to start investing in my TSP, I’m going to be auto invested in an L Fund, right? With one that’s got a deadline of about when I might expect to retire. Is that how they set it up initially?

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Art Stein That’s how they set it up initially, that if a new employee does not make a specific choice to invest in a specific fund, then they’re automatically enrolled in the TSP with a 5% withdrawal from their paycheck to be invested. They get a 5% match on that, which is fabulous, all of a sudden you’ve doubled your money. And they are invested in an L Fund, which should be retired about the time that they would reach age 65. It’s based on the age of the new employee.

Terry Gerton So if I want to have a little more control over what my TSP investments might be, how do I then think about what my choices would be?

Art Stein Okay, well the choice is you can have any allocation you want among the five traditional funds and the 11 L funds. You just have to get on the TSP website and make whatever allocations you choose. And of course the allocation of the money that you currently have in the TSP can be modified to whatever you want. And the allocation in the money that’s being invested every two weeks when your paycheck comes out, that can have a different allocation than the money that’s already in the fund. So some people, you know, later in their life might want to be more money in the F and G funds because they’re very close to taking the money out, but still want to aggressive for the money, the much smaller amounts that are being invested every two weeks.

Terry Gerton I’m speaking with certified financial planner, Art Stein of Arthur Stein Financial. All right. So my money goes into the L Fund. I can set it and forget it, except you’re saying I shouldn’t. I should be thinking about managing my balance between risk tolerance and return as I get older and as I might think about a more immediate need for those TSP funds.

Art Stein Absolutely, and remember, inflation is kind of a silent killer. Your money might be increasing in value, but it doesn’t mean that the purchasing power is going up, that you have more money to spend.

Terry Gerton Let’s just talk a little bit about purchasing power, Art, because it can be sort of a financial term of art, but it has real implications.

Art Stein One example I use is just look at first-class stamps. I mean, how many first- class stamps could you purchase with a dollar? Well, that’s going down, you know, year by year, right? First-class stamps used to be about five cents. Now I think they’re closer to 60 cents. That’s inflation. And so if your investment isn’t going up fast enough to keep up with that, after taking into account the taxes you’re going to pay when you withdraw the money from the TSP, then you’re losing purchasing power.

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Terry Gerton So it’s a balance between inflation and the rate of return on the underlying investment, what my taxes will be when I have to pay them on the withdrawal, and then the overall earnings. All of those things together, it can get a little complicated. What should people be thinking about when they’re considering all of those things together? The lifestyle they want, this TSP to contribute to?

Art Stein Well, they want a significant portion of their TSP investments to be in the stock funds, in the C, S and I. And certainly in the beginning, for new employees in many years thereafter, if they’re automatically enrolled in an L Fund, that works for them because there’s just a significant amount going into the stock fund. It’s when they’re getting ready for that L-Fund to be retired, retired being the term that’s used, that they need to think about, well, this fund has become very conservative and if it’s retired and I just let money automatically go into the L income fund, which is super conservative, then I’m going to be losing a lot of purchasing power and I need to do something about that. Because, Terry, in today’s world, you know, people retire at 65 and they could easily be alive for 30 years. That’s an incredibly long period of time to be managing your investments. And it’s a very long period of time to be continually losing purchasing power every year.

Terry Gerton So the longer your work horizon and the longer, your investment timeframe, the more heavily weighted your stock investment portfolio can be, which is what I hear you saying the L Funds are at the beginning. And then as you get older, you want to shift to less volatile, more predictable, but sadly lower earning rates.

Art Stein Yes, but not too much. It’s just instead of 99% stocks and 1% bonds, which is what you start with, and instead of the 36% stocks that you end up with the L Fund, maybe something more like 50% stocks or 60% stocks. Because it’s those stock investments you’re keeping in your portfolio, because you’re going to need that money to spend in 10 or 15 or 20 or even 30 years.

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