You’ve read steps 1, 2, and 3 to crush the Thrift Savings Plan (TSP), and now you’re ready for step 4 and to start investing. In step 3 you came up with your desired asset allocation, so make sure you have that. You’re going to need it for the rest of the post. Just to make life a little easier, we’re going to use an example asset allocation of 80% stocks and 20% bonds.
For the bond portion of your asset allocation, you only have two investment choices:
- G Fund – US government bonds (specially issued to the TSP)
- F Fund – US government, corporate, and mortgage-backed bonds
Both of these are US bond options, which is just fine. There are no international bonds available in the TSP.
We could have an intellectual discussion about the subtle differences between these two bond funds, but we’re not going to. It isn’t necessary. They’re both fine bond funds, so just split the difference, diversify, and put half of your bond allocation in the G fund and half in the F fund.
To illustrate, in the example allocation of 80% stocks and 20% bonds, we’d put 10% in the G fund and 10% in the F fund.
That’s it. The bonds are done.
The Stock Allocation
This is a little more complicated. The largest decision you have to make is how you’re going to divide your stocks between the three options. Here are your choices:
- C Fund – stocks of large and medium-sized US companies
- S Fund – stocks of small to medium-sized US companies (not included in the C Fund)
- I Fund – international stocks of more than 20 developed countries
The first question is what percentage of your stock allocation should go to the I fund. There are a few schools of thought on this.
John Bogle, the founder of Vanguard, is famous for believing that you don’t need to invest any of your stocks in international stocks. His long held belief was that the US companies are doing business globally, so they are already worldwide diversified. For example, Coca-Cola is clearly selling Coke products all over the globe. He would say you should put 0% of your stocks in the I fund.
At the other end of the spectrum are people who believe that you should invest proportionally. If you look at the worldwide value of stocks, it is about a 50/50 split between the US and the rest of the world. These people would say you should put 50% of your allocation in international stocks.
Both of these opinions are reasonable, so anything between 0% and 50% allocated to the I fund is fine. What do I do?
I rely on the research done by Vanguard, an institution managing over $5 trillion. I figure they have more money and resources to research this stuff than I do. What does Vanguard do?
If you look at their Target Retirement Funds, which are meant to be a “one stop shop” kind of investment fund, you’ll notice that they split their stock allocation so that 60% is US and 40% is international. They used to do it 70% US and 30% international, but their research showed 60/40 to be a better split so they moved to it a few years ago.
You’ll notice that a 40% international allocation is between the 0% Bogle viewpoint and the 50% global weighting viewpoint, so it seems fine to me and that is what I do.
If you want another opinion, you can look at the TSP Lifecycle funds. You’ll notice that they do about a 70% US and 30% international split, like Vanguard used to do. Again, that seems reasonable.
Ultimately, you can pick anywhere from 0% to 50% and find someone really smart who agrees with you. I’d encourage you to have some exposure to international, so I’d say you should pick at least 20%, but it really is up to you.
Not sure what to do? Go with 30% (the TSP Lifecycle approach) or 40% (the Vanguard approach) for the I fund and call it a day.
How to Split the C and S Funds
This is easier, or at least I think it is. The C fund is basically an S&P 500 index fund of large companies, with the S fund having the rest of the small and medium sized companies. If you want to mirror the US stock market, you want to put about 75% of your US stock allocation in the C fund and the other 25% in the S fund. You’ll notice that this is what the TSP Lifecycle funds do, further backing up my assertion.
So, I recommend that you split your C and S fund allocation 75/25, respectively.
Putting the Stock Portion All Together
For the stocks, here’s the math:
- (Your desired international stock %) X (your total stock allocation %) = % that goes in the I fund
- (Your total stock allocation %) – (% you are putting in the I fund) = % you must divide into the C and S funds
- (Your % you must divide into the C and S funds) X 0.75 = % that goes in the C fund
- (Your % you must divide into the C and S funds) X 0.25 = % that goes in the S fund
Let’s use the 80% stock and 20% bond example we started with to illustrate. Let’s assume we’re going with a 40% desired allocation to international (like I personally use):
- (Desired international stock = 40%) X (total stock allocation = 80%) = 32% goes in the I fund
- (Total stock allocation = 80%) – (32% that is going in the I fund) = 48% we must divide into the C and S funds
- (48% we must divide into the C and S funds) X 0.75 = 36% that goes in the C fund
- (48% we must divide into the C and S funds) X 0.25 = 12% that goes in the S fund
That gives us a stock allocation of 32% I fund, 36% C fund, and 12% S fund.
The Bottom Line
We split our bond allocation 50/50 between the G and F funds. We put the desired percentage for international stocks in the I fund. We split the remaining stock allocation 75/25 between the C and S funds, respectively.
For the 80% stock and 20% bond portfolio we are using as an example, this plays out:
- 10% in the G fund
- 10% in the F fund
- 32% in the I fund (based on a hypothetical 60/40 US/international stock split, which can vary as discussed above)
- 36% in the C fund
- 12% in the S fund
This can be tough to grasp in a blog post, so if there are questions or points that need clarification just put them in the comments section and we’ll straighten them out.
The next step you need to crush the TSP is to decide if you’re going to go Roth or traditional.