Investing

What Do You Think of the Thrift Savings Plan?

Path to Savings

Did you know there’s a way to identify a good investment advisor (or investor!) by asking them a single question?

It’s true. The question is: What do you think of the TSP?

The Thrift Savings Plan (TSP) is the 401(k)-like retirement savings program for federal employees, including members of the armed forces. It has over 4.5 million members.

Plenty of government programs are bloated, complex, and ineffective. The TSP isn’t one of them. The correct answer to the question is, “It’s great, and it should be open to everyone.” Here’s why.

The TSP is simple

Unlike some 401(k)s that offer dozens of investment options, the TSP only offers five basic funds, plus a suite of target-date funds. The basic funds are:

  • C fund. A large-company stock index fund that mirrors the S&P 500.
  • S fund. A small company stock index fund that mirrors the performance of all US stocks not in the S&P 500.
  • I fund. An international stock fund that mirrors the MSCI EAFE index.
  • F fund. A bond fund that mirrors the Barclays Aggregate US Bond Index.
  • G fund. Holds government bonds that pay interest equivalent to Treasury bonds with maturity of 4 years and up, but with no interest rate risk. In other words, you can never lose principal in the G fund.

With the exception of the G fund, these are all plain-vanilla index funds, the kind that beat the vast majority of actively managed funds over time. There are no actively managed funds in the TSP.

The TSP also offers a suite of target-date funds which roll the five basic funds into a single fund that grows more conservative over time. The L 2030 fund, for example, holds 67% stocks and 33% bonds.

While it might seem like it would be nice to have an endless salad bar of investment choices, more choices don’t lead to better investing decisions. Faced by a bewildering array of options, investors often respond by splitting their dollar evenly between all the available funds, or just doing nothing and letting their money sit in cash or a default fund that might not be appropriate for them.

The TSP is cheap

Because the TSP is huge, it can negotiate ultra-low prices. The average large-company 401(k) charges participants 1.03% per year in fees and expenses, according to the annual 401k Averages Book survey. The TSP charges 0.027% per year. Yes, that means the average large-company plan is 38 times as expensive as the TSP. The TSP is also cheaper than any mutual fund or ETF you can buy through your IRA.

Every dollar you spend on investment fees and expenses represents, through the power of compound interest, many dollars you’ll never be able to spend in retirement.

The TSP includes a special deal

The G fund offers relatively high-yielding bonds with none of the risk of high-yield bonds. Of course, in the current environment, “relatively high-yielding” is still less than 2%. Still, it’s probably better than any bond fund available in your 401(k).

Why some some financial advisors hate the TSP

You can see, I hope, why the TSP is great. Obviously, the best advice you can give to anyone with access to the TSP is to save as much money in it as possible.

So why would anyone advise anything else? Two reasons.

1. Advisors who make money selling products on commission don’t make a dime when you put more money into the TSP. If they can convince you that the TSP is a risky government scam or doesn’t offer the kind of investments you deserve, they can turn more of your money into their money. This type of advisor is commonly found near US military bases, giving soldiers the hard sell.

2. Brokers who want you to believe that they can beat the market by trading stocks or choosing the right slate of actively managed mutual funds will try to tell you that the TSP’s reliance on index funds dooms you to merely average performance. This is wrong. Once fees and taxes are taken into account, the vast majority of active investors underperform low-cost index funds. Trying to beat the market through active management is a poor strategy.

Now, what good does any of this do you if you don’t work for the US government?

Easy. If you’re interviewing financial advisors, ask them about the TSP, even if you’re not a member. Obviously, being in love with the TSP isn’t the only thing you should look for in an advisor, but any advisor who reflexively badmouths the TSP isn’t looking out for your interests.

Second, you can invest as TSP-like as possible in your own 401(k) or IRA. Choose the simplest, cheapest index funds you can. If it seems too simple to be real investing, you’re probably on the right track.

Matthew Amster-Burton is a personal finance columnist at Mint.com. His new book, Pretty Good Number One: An American Family Eats Tokyo, is available now. Find him on Twitter @Mint_Mamster.