User:Hoppy08520/TSP role in a portfolio
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|This is a VERY ROUGH draft that I'm working on for a regular article that will link from the TSP page.|
The Thrift Savings Plan is a retirement plan for civilian and military employees of the United States Government.
For many TSP participants, the selection of the Lifecycle Fund closest to their desired asset allocation may be a suitable investment choice, especially if the TSP is the participant's only retirement account.
Complexity typically arises when a TSP participant has other retirement accounts or has a spouse with additional retirement accounts. In these scenarios, while a Lifecycle Fund may still be a good choice, there can be advantages to using the TSP's specific funds in a more strategic way to achieve the following objectives:
- Compensate for inefficient or more expensive funds or asset classes in the other accounts;
- Minimize or eliminate the need to hold the international I Fund in the TSP, owing to the I Fund's limitations;
- For investors who want the G Fund in their portfolio, hold an outsized portion of their TSP in the G Fund, as this fund is not available outside the TSP.
Many of these considerations are explained in Asset allocation in multiple accounts. This page discusses these themes from the specific perspective of a TSP participant.
Compensating for missing asset classes in other accounts
For a TSP participant who has a spouse with a 401(k)/403(b)/457(b) retirement plan, or if the participant has left Federal service and has one of these plans, then they may find that the employer plan might not have suitable choices in a particular asset class. If the investor seeks to have a diversified retirement portfolio, then the gap in the employer plan may need to be filled by holding all or more of that particular asset class in other accounts, such as the TSP. For example, suppose the 401(k) plan has no desirable fixed income fund. This may, in turn lead the investor to hold more bonds in the TSP's fixed income funds in order to get the overall portfolio's bond allocation at its target.
Following this approach, the employer retirement plan's lowest and most appropriate fund might be a S&P 500 index fund. This is a a common trait of many, but certainly not all, employer retirement plans. If the investor wants to minimize fund expenses, then the best course of action may be to concentrate all of the account in that one 500-index fund. This will, in turn, mean that the TSP account should hold a correspondingly lower amount of the C Fund, whose benchmark is also the S&P 500 Index, and more of the S Fund, which is an Extended Market (completion) fund for S&P 500 index funds.
This particular scenario is illustrated in the following scenario. Suppose an investor with a TSP seeks to have an overall portfolio with 60% stocks and 40% bonds, and with 30% of stocks in international. The TSP participant is married to a person with a 401(k) with a low-fee S&P 500 Index Fund and a moderately expensive intermediate-term bond fund; the only US small-cap stock funds and the only international funds are more expensive actively managed funds. To minimize fund expenses and work around inferior funds, the spouse with the 401(k) plan would like to concentrate her account with the 500-index fund and the bond fund. Consequently, the TSP will need to hold less C Fund and F Fund, and more of the I Fund and S Fund.
Here's an example with a TSP balance of $100,000 and a 401(k) balance of $80,000:
(View Google Spreadsheet in browser, then File --> Download as to download the file.)
Looking at the spreadsheet tabs, from left to right, illustrates how this portfolio can be achieved in the two accounts.
- Allocations tab - shows the desired percentages in each asset class: large-cap US stocks, extended market US-stocks, international stocks, bonds, and G Fund.
- Accounts & Funds tab - shows how the specific funds in each of the two accounts are allocated in such a way as to achieve the desired asset allocations in the first tab.
- Charts - contains three pie charts. The top chart shows the desired allocations for the overall portfolio, by asset class. The two charts on the bottom show how each of the two accounts is sliced into various funds to achieve the overall asset allocation in the top chart.
By splitting the accounts as shown in the case study above, each account is not balanced and diversified properly within each account in isolation, but when both accounts are combined into a unified whole, then the desired asset allocation targets are achieved. In this scenario, the only asset class that is held in both accounts is the intermediate-term bonds.
I Fund and international allocation
|This section uses case studies to illustrate how a TSP participant might manage their investments. Each investor and portfolio is unique, and therefore this case study might not apply to all TSP participants and their own specific portfolios and investing philosophy.|
The TSP’s international fund is an incomplete fund if an investor wishes to capture the entire investable international market, owing to the fact that it tracks the MSCI EAFE index of large-cap developed markets. A TSP participant who wishes to capture the complete investable international market has two options:
- Don’t use the I Fund in the TSP, and use a total-market fund like Vanguard’s Total International Stock Market Index Fund in other investment accounts (IRAs, taxable accounts, etc.) to hold the international equities allocation.
- Use completion funds in other accounts to complete the I Fund holding in the TSP.
The first option is the simpler option, but it’s only possible if you have space in your other retirement accounts outside the TSP.
Determining international investment options
To determine if there is space outside the TSP, first calculate the percentage of desired international allocation in the complete portfolio. For example, if the overall asset allocation is 60% stocks and 40% bonds, and and the equity split is 70% US and 30% international, then the international allocation target is 60% * 30%, which is 18% of the overall portfolio.
Next, figure out if there is space in the accounts outside the TSP to hold the I Fund.
For example, if there is $100,000 in the TSP and $1,000 in an IRA and another $2,000 in a taxable investment account, then clearly there isn't space. This investor will need to hold the I Fund in the TSP. If desired, the investor could use the $3,000 in the other accounts for completion indexes, or simply hold some of the Vanguard fund in the other accounts as a small part of the international allocation.
But suppose the investor has $100,000 in the TSP and $30,000 in an IRA. In this case, there is $130,000 in total retirement assets. In this example, the target international allocation is 18%, which is $23,400. In this case, the investor could leave the I Fund out of the TSP account altogether and just hold $23,400 of the Total International Stock Market Index Fund in the IRA.
International allocation outside TSP
Continuing with the case study above with the investor with $100,000 in the TSP and $30,000 in an IRA, and looking at the rest of this sample portfolio, assume a mix of C Fund and S Fund of 3:1 and a 1:1 mix between G Fund and F Fund; different investors may opt for different allocations. With these ratios, we arrive at the following targets for various asset classes,
|Large-Cap US (C Fund)||31.5%||(60% stocks * 70% US *75% Large-cap)|
|US Extended Market (S Fund)||10.5%||(60% stocks * 70% US *25% Large-cap)|
|International||18%||(60% stocks * 30% International)|
|Total Bond Market (F Fund)||20%||40% bonds * 50%)|
|Govt Treasuries (G Fund)||20%||(40% bonds * 50%)|
Next, apply these desired targets to the overall portfolio. Starting with the IRA, allocate the entire international allocation of $23,400 to Vanguard Total International Stock Market Index Fund in the IRA. There is still $6,600 left over in the IRA. For this case study, allocate that toward the bond allocation using the Vanguard Total Bond Market Index Fund (VBMFX), which tracks the same index as the F Fund.
Moving to the TSP account, allocate $26,000 to the G Fund and $13,650 to the F Fund (to get to $26,000 overall when combined with the F Fund balance in the TSP with the Vanguard Total Bond Market Index Fund in the IRA). Finally, allocate the desired US stock holdings to the C Fund and S Fund. Overall, we arrive at the following:
|IRA||Vanguard Total International||$23,400|
|IRA||Vanguard Total Bond||$6,600|
The portfolio above, split between the two accounts, arrives at the overall desired asset allocation and takes the international allocation out of the TSP altogether.
International investing with the I Fund and other accounts
In the first scenario above, the investor has sufficient space in investment accounts outside the TSP to hold their entire international allocation.
An investor without this option who must hold a portion of their international allocation in the TSP's I Fund may add completion funds in outside accounts to hold a complementary emerging markets fund and/or a small-cap international fund and/or a Canadian total stock market fund.
For example, consider an investor with the same asset allocation targets in the case study above: a 60/40 stock/bond split, with a 70/30 US/International split. Suppose the investor has $100,000 in the TSP and $10,000 in an IRA. The target international allocation is 18% of the $110,000 portfolio, which is $19,800. With only $10,000 in accounts outside the TSP, there isn't enough space to hold the complete international allocation. The investor has the following options:
- Determine a slice-and-dice international allocation composed of the I Fund and other international funds such emerging markets, small-caps, and possibly others.
- Hold all $10,000 in the IRA in Vanguard Total International Stock Market Index Fund, and $9,800 in the I Fund, and allocate the rest of the funds in the TSP to fill the other asset class targets. For scenarios like this, where half or less of the international allocation is to be in the TSP, this might be simpler_______________ (need to explain this better)
See Approximating Total International Stock Market for more guidance on different funds and the ratios to hold them in.
Slice and Dice
For example, suppose the investor chooses hold the following international allocation split between the TSP and the other account:
|emerging markets fund||25%||$4,950|
|small-cap international fund||10%||$1,980|
Allocating to these targets is similar to the first case study. First allocate to the international funds in the IRA. Fill the rest of the IRA with Vanguard Total Bond Market Index Fund. Then allocate in the TSP to each fund:
|IRA||Emerging Markets Fund||$4,950|
|IRA||International Small-cap Fund||$1,980|
|IRA||Vanguard Total Bond Market Index Fund||$3,070|
Total International in IRA
The second option simply holds a total-market international index fund in the IRA, along with the I Fund in the TSP. While this allocation will result in underweighted allocations in the asset classes not contained in the I Fund, and consequently overweighted to the international developed large-cap in the I Fund which will be duplicated in the total-market international fund in the IRA, this solution has the benefit of being a simpler and easier to manage portfolio.
|IRA||Vanguard Total International Stock Market Index Fund||$10,000|
Considerations for International Investing beyond the I Fund
An investor who desires the convenience and simplicity of holding a Lifecycle Fund in their TSP must weigh those benefits against the potential advantage of holding a more complete international allocation.
An investor who chooses to split their TSP funds out in order to minimize or eliminate the I Fund in the TSP must be willing and able to administer the additional complexity this will bring to the portfolio.
The case study for international investing and the I Fund can be viewed in this spreadsheet:
(View Google Spreadsheet in browser, then File --> Download as to download the file.)