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Federal Thrift Savings Plan changing lifecycle fund allocations

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On March 26, the Thrift Savings Plan (TSP) announced changes to allocations within the lifecycle funds (L funds) for federal employees. The L funds are similar to the "target retirement investment funds" available from various mutual fund companies in that the allocations in each are geared to the approximate time of a person's retirement.

The changes to the TSP will become effective in April 2014.

The new allocations suggest concerns by the TSP that interest rates may rise with the "tapering" of bond buying by the Federal Reserve. While the allocation changes are small ones, the TSP will be putting a higher percentage of investors' funds into the Government Securities Investment Fund (G fund) and less into the more traditional bond fund (The Fixed Income Index Investment Fund or the F fund) for the more conservative lifecycle funds. (See the allocation percentages below.)

There has been a significant increase in the G fund allocations over the F fund in the past year. The result is that there is now a significantly larger percentage going into the G fund. The TSP may have decided that approach was overdone. For the more aggressive TSP funds (The L2050 and L2040), the new allocations will place a little less into the G fund and more into the F fund. This change is not surprising as the F fund went down in value last year and diversification and rebalancing to reflect changes in investment values are major features of these funds.

The G fund features bonds that are issued only to the Thrift Savings Plan. G fund investors who invest in the G Fund receive a long-term rate on a short-term security.

The new quarterly allocations for the lifecycle funds are not dramatically different. The TSP changes or at least reviews allocations each quarter for the L funds. The lifecycle income fund (or I fund) usually remains the same. It is the most conservative of the L funds and designed for those who are retired or close to retirement.

The investment strategy of the L funds is not complicated, at least for the TSP investor, and it is designed to be easy to understand. “The L Funds’ strategy is to invest in an appropriate mix of the G, F, C, S, and I Funds for a particular time horizon, or target retirement date. The investment mix of each L Fund becomes more conservative as its target date approaches.” An investor will be moved into the more appropriate lifecycle fund automatically as a federal employee nears retirement.

Greater risk for a fund means a larger investment in the underlying stock funds (the C, S and I funds). Investing more in stock funds also means that there is a potential for a greater return than investing in bonds. There is also a greater chance that the stock funds will lose money, at least in the short term. The annual returns of each of the underlying funds are available in the TSP Data Center.

Here are the current allocations and the changes being made to the lifecycle funds:

L2050 Fund

Current Allocation: April 2014 Allocation:

G Fund: 10.8% G Fund: 10.68%
F Fund: 2.70% F Fund: 3.07%
C Fund: 42.60% C Fund: 42.50%
S Fund: 18.30% S Fund: 18.25%
I Fund: 25.60% I Fund: 25.50%

L2040 Fund

Current Allocation: April 2014 Allocation:

G Fund: 18.8% G Fund: 18.78%
F Fund: 4.70% F Fund: 4.97%
C Fund: 38.60% C Fund: 38.50%
S Fund: 16.30% S Fund: 16.25%
I Fund: 21.60% I Fund: 21.50%

L2030 Fund

Current Allocation: April 2014 Allocation:

G Fund: 28.48% G Fund: 28.53%
F Fund: 5.02% F Fund: 5.22%
C Fund: 34.60% C Fund: 34.50%
S Fund: 12.60% S Fund: 12.50%
I Fund: 19.30% I Fund: 19.25%

L2020 Fund

Current Allocation: April 2014 Allocation:

G Fund: 42.98% G Fund: 43.20%
F Fund: 4.77% F Fund: 4.93%
C Fund: 28.05% C Fund: 27.87%
S Fund: 8.60% S Fund: 8.50%
I Fund: 15.60% I Fund: 15.50%

Income Fund

Allocation Does Not Change:

G Fund: 74%
F Fund: 6%
C Fund: 12%
S Fund: 3%
I Fund: 5%

Minor changes are routinely made to allocate more money into bonds (the F and G funds) and less into stocks when the quarterly allocations are revised. The changes in the allocations are usually small as the investments are intended to be made over the life of a person’s government career. Also, as markets change, the TSP routinely balances the allocations to provide the desired diversification in a person’s investments that may have been altered during periods when the stock market has been going up or down significantly.

There will also be changes due to “long-term capital market assumptions.” We do not know what these assumptions are that go into the L fund allocations but the changes that are made provide insight into these assumptions.

For example, in January 2013, the L2050 fund had 8.33% of funds invested in the F fund. 4.17% was invested in the G fund. By January 2014, the L2050 fund changed significantly. 10.80% was invested in the G fund. Only 2.70% was in the F fund. The implication is that the allocations were changed in January 2014 based on a more negative prognosis for investments in the F fund and may be more risky for the most conservative funds. The F fund was the only TSP fund that went down in value in 2013 losing1.68%.

We have been in a period of very low interest rates for some time, due in large part to actions by the Federal Reserve to buy government bonds to keep interest rates low. This has been an incentive to invest in stocks and stock prices have gone up significantly in this time period.

The Federal Reserve is now reducing bond purchases and interest rates may start to go up again. If that happens, the value of F fund shares are likely to decline as there is often a negative correlation between interest rates and bond prices.

The G fund, on the other hand, is less volatile. The bonds in the G fund are short-term bonds and the rate changes each month with bonds that are just being issued specifically for the TSP. In some investing environments, an investor is likely to have a better return in the F fund because interest rates paid to investors may be higher and the value of the fund will often go up when interest rates drop.

In the current environment, a reasonable assumption would be that the G fund is a safer investment as interest rates may go up. If that occurs, the value of shares in the F fund are likely to go down.

For those who do not take an interest in changes in the investment climate, the lifecycle funds provide automatic diversification without any action having to be taken by an investor. These funds are becoming more popular among TSP investors as they are often seen as a way to invest for future retirement income without having to spend time and effort studying the stock market. The quarterly allocation adjustments made by the TSP are an example of how these investments change over time to reflect alterations in the stock and bond markets and become more conservative as an investor gets nearer to retirement.

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