For quite some time now, I've been enviously looking in from the outside at what is easily the best 401(k) retirement plan in the country - The U.S. Government's $254 billion Thrift Savings Plan (TSP).
Several years ago, I had the good fortune to get to know Mike Causey, senior correspondent for Federal News Radio. He was extolling the many benefits of the TSP so I thought I'd check it out, and what I discovered blew me away.
Thrift Savings Plan highlights
- Simplicity - Five core investment options.
- Diversification - Four of those five options give exposure to the entire U.S. stock market, most of the international stock market, and the U.S. aggregate bond market.
- A special government fund that yields longer term bond returns without any loss of principal.
- Ultra low costs - Less than 0.03 percent annual costs.
- Lifecycle funds that own all five core investments, rebalance automatically, and become more conservative over time - all for no additional costs.
I agree with Walter Updegrave of Money Magazine that this is the retirement plan that Uncle Sam has right. It is the simplicity of this plan that makes it particularly effective, because studies show the more choices that are offered, the less likely people are to choose. And the diversification of this plan protects investors from chasing the part of the stock market that has recently gone up.
Costs really matter - the 0.03 percent annual expense ratio compares to the 401(k) industry average expenses of 2.00 percent, as noted by a recent LA Times article by fellow blogger Kathy Kristof. To put the costs in perspective, the average 401(k) plan costs 67 times the amount of the TSP, and even my own portfolio is about five times more expensive. Hence the envy I have for this plan.
TSP is getting even better
What could be better than the TSP 401(k)? How about a Roth TSP 401(k) to go along side this traditional plan? Well, the TSP is working on this but must first coordinate it with all the government agencies and their payroll. Though no small task, the Roth TSP 401(k) will be coming.
Even a great plan isn't perfect
I recently spoke to the plan's executive Director, Greg Long, and the chief investment officer, Tracey Ray. We went over the many virtues of the plan but, in my typical tactless fashion, I had to ask a few difficult questions.
I asked why the international fund only invests in developed countries in Europe, Australia, and the Far East (EAFE). It excludes emerging market countries and Canada, which happen to have been the best performers of international investing. Ms. Ray explained that the first generation international funds were EAFE funds and, to date, the TSP has been unable to find the provider of an index fund which includes emerging markets and Canada and has daily liquidity with low tracking error. For now, the best solution for Federal employees is to complete their international portfolio by having some emerging market and Canada equities in their taxable portfolios.
Next, I noted an observation from the TSP's fund flow statements that shows Federal employees tend to time the market pretty badly, just like the rest of us. Before the 2008 plunge, more funds flowed into stocks and, after the plunge, fixed income became popular as stocks recovered. Mr. Long explained the TSP tries to minimize performance chasing by limiting trades to two per month and educating employees.
A major threat to the plan?
Mr. Long stated that a vocal minority wants access to more choices. Of course, the mutual fund industry would also like to get their hands on as much of the quarter trillion dollars in this plan as they can. Congress recently authorized the TSP to look at providing a mutual fund window that would allow open access to all mutual funds. The TSP is still studying that option, but if it were implemented, the mutual fund investors would pay their own way so that the 0.03 percent expense ratio isn't compromised.
This, of course, could allow the mutual fund industry to sell their expensive hot funds. The bad news is that it will almost certainly result in lower returns. The good news is that it could also provide the missing part of the international portfolio - emerging markets and Canada. How this is implemented will be key.
One more reason to use the TSP as a model for all 401(k) plans
As compelling as the TSP is, the final proof that this is the model for all 401(k)s is the fact that the financial industry hates it. The Investment Company Institute, the trade organization for mutual funds, published a paper questioning the TSP as a model for 401(k)s. You can bet that anything that threatens the mutual fund industry's profits is probably a good thing for investors.
I'm with advisor and author Dan Solin that the TSP is the model to stop the great 401(k) rip-off. I'm not making a political statement when I say that I would jump into the TSP if I were offered the opportunity. It would simply lower my costs and increase my returns. It's unfortunate that I'm not making a political statement, because getting elected to political office would be my only chance to get access to the TSP.
My advice to Federal employees is to keep your money in the TSP plan, in spite of many of my fellow planners telling you to dump it as soon as you can. I'm happy to say that, according to TSP spokesperson, Thomas Trabucco, that's exactly what most former Federal employees are doing.
My advice to the rest of us is to apply the dull principles behind the TSP as best as we can.
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