Building and managing a Thrift Savings Plan account is like mining for coal. It takes expertise, ability and the right tools to do the job right and safely. If you don’t know what you’re doing, going to the store for more dynamite probably isn’t going to help you be more successful, and will probably just get you into trouble.
In the case of your TSP account, if you know what you’re doing, you should realize that you don’t need more investment options to do the job right. You already have what you need to do the job the TSP was intended to do, about as well as it can be done.
You don’t need more TSP investment options to support a better standard of living in retirement; you just need to use the ones already there more effectively. Contrary to popular opinion, adding gold, real estate or other managed investment fund options to the TSP will not allow you to produce and manage a meaningfully better portfolio, unless “riskier” or “more speculative” is synonymous with your definition of “better.” If they are, then you should find another place to invest your money, since that’s not what the TSP is intended for.
To understand why this is true, you must first define what a “better” portfolio is when it comes to investing for maximum sustainable retirement income. While higher rates of return tend to increase the retirement income your TSP can provide, volatility or downward fluctuations in the value of your account tend to reduce it. An asset allocation scheme with a higher expected rate of return may actually support a lower income level than one with less volatility.
That’s right: When choosing your investment strategy, the one with the lower rate of return may actually be the better choice. Simply shooting for the highest expected rate of return can hurt you if you’re not careful. Managing money to support the maximum safe retirement income requires carefully tuning expected returns and risk in a way that optimizes the balance between the two.
An investment portfolio that optimizes this risk and return relationship is said to be risk-efficient and, surprisingly, it doesn’t take anything too exotic to create it. A few low-cost market index funds will do the trick. The TSP already contains everything you need to do the job quite well with its C, S, I, G and F Funds. In fact, you’d need only three funds to do the job well — one fund that combines the C and S Funds, the G Fund and the F Fund. These three funds, if configured properly, would allow you to create portfolios that could be expected to produce the highest risk-adjusted returns possible.
Rather than improving risk efficiency, the S and I Funds tend to diminish it, allowing you to concentrate risk, rather than diversify it away. This would also be true for other options that have been proposed over the years for the TSP.
Using the current selection of funds, it’s possible to create a portfolio with virtually any risk and return profile you’d be able to obtain with a wider selection of funds. In most cases, you would be able to build better portfolios without additional funds than with them, since adding them would tend to either reduce expected return faster than it would reduce portfolio risk, or vice versa.
The demands to add more risky investment alternatives are inconsistent with the TSP’s intended use — saving and investing for retirement income — and will not improve its utility to this end. If studying, analyzing, considering or adding and administering an additional investment option adds cost, which it must, then every participant will pay the price. Since additional expenses directly reduce expected rates of investment return, the price paid will take the form of lower returns and, in turn, less retirement income to enjoy.
Increased risk combined with reduced rates of return is not an intelligent investment objective. Yet that’s what certain special interests, including some speculative TSP participants, seem to keep demanding from the TSP. For the sake of the majority of participants, who want only to use the TSP for its intended purpose, let’s hope the TSP’s managing board continues to resist this pressure.