personal finance

Thrift Savings Plan Fund Deep Dive – The S Fund

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There are only five investments available in the Thrift Savings Plan (TSP), so let’s take a detailed look at them one at a time. In this post we’ll cover the S Fund. You can combine the S Fund with the C Fund to invest in the entire US stock market.

Inception Date

1 MAY 2001

Fund Management

The Federal Retirement Thrift Investment Board currently contracts BlackRock Institutional Trust Company, N.A. (BlackRock) to manage the S Fund assets. The S Fund remains invested regardless of the performance of the securities markets or the overall economy.

Investment Strategy

The S Fund is invested in a stock index fund that invests in small to medium-sized U.S. companies that are not included in the C Fund. The S Fund’s objective is to match the performance of the Dow Jones U.S. Completion TSM Index, which means that when you combine the S Fund and C Fund you are investing in the entire US stock market. Also, some of the money in the S Fund is temporarily invested in the G Fund and earns the G Fund return.

The S Fund is a passively managed fund that remains invested according to its indexed investment strategy regardless of stock market movements or general economic conditions.

What is the Risk?

Your investment in the S Fund is subject to market risk because the prices of the stocks it invests in rise and fall. You are also exposed to inflation risk, meaning your S Fund investment may not grow enough to offset inflation.

What is the Benefit?

Historically, this increased risk has been rewarded with an increased return. It offers the opportunity to experience gains from equity ownership of small and medium-sized US company stocks. Here is all the performance data as of 26 SEP 2019:

Screen Shot 2019-09-26 at 9.38.20 PM

Types of Earnings

The S Fund changes in value as the market price of its stocks change. In addition, the S Fund makes money for its investors when those stocks pay dividends. Unlike a traditional mutual fund, though, income from dividends is included in the share price calculation. It is not paid directly to participants’ accounts.

It also makes some money on interest on short-term investments and securities lending income.

BlackRock credits interest and dividend income each business day. This income is then reflected in the TSP share prices.

Share Price Calculations

The value of your account is determined each business day based on the daily share price and the number of shares you hold. At the end of each business day, after the stock and bond markets have closed, the total value of the funds’ holdings (net of accrued administrative expenses) is divided by the total number of shares outstanding to determine the share price for that day. The daily change in TSP share prices reflects all investment income (interest on short-term investments, dividends, capital gains or losses, and securities lending income) net of TSP administrative expenses.

Expenses

The net expenses paid by investors is 0.040% or 4 basis points, which like all the TSP funds is ridiculously low and is a major benefit of the TSP. It cost $0.40 for each $1,000 invested.

How Should I Use the S Fund in my TSP Account?

The S Fund can be useful in a portfolio that also contains stock funds that track other indexes such as the C Fund (which tracks an index of large U.S. company stocks) and the I Fund (which tracks an index of international stocks). The C, S, and I Funds track different segments of the overall stock market without overlapping. This is important because the prices of stocks in each market segment don’t always move in the same direction or by the same amount at the same time. By investing in all segments of the stock market (as opposed to just one), you reduce your exposure to market risk.

The S Fund can also be useful in a portfolio that contains bonds. Again, it is because the prices of stocks and bonds don’t always move in the same direction or by the same amount at the same time. So a retirement portfolio that contains a bond fund like the F Fund, along with other stock funds, like the C and I Funds, will tend to be less volatile than one that contains stock funds alone.

Advice from My Favorite Short Investing Book

Here is what my favorite investing book, The Elements of Investing: Easy Lessons for Every Investor, says about small and mid-cap funds like the S Fund:

The S&P 500 [C Fund in the TSP] represents only about 70 percent of the total value of all stocks traded in the United States. It excludes the 30 percent made up of smaller companies [which are in the S Fund], many of which are the most entrepreneurial and capable of the fastest future growth.

If you want to invest in the entire US stock market, you just combine the C Fund with the S Fund in a 3:1 ratio. To see how I use the S Fund, read the Crush the TSP series.

Thrift Savings Plan Fund Deep Dive – The C Fund

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There are only five investments available in the Thrift Savings Plan (TSP), so let’s take a detailed look at them one at a time. First, we’ll cover the C Fund, which would probably be the fund you would pick if you were only allowed to pick one.

Inception Date

29 JAN 1988

Fund Management

The Federal Retirement Thrift Investment Board currently contracts BlackRock Institutional Trust Company, N.A. (BlackRock) to manage the C Fund assets. The C Fund remains invested regardless of the performance of the securities markets or the overall economy.

Investment Strategy

The C Fund is invested in a stock index fund that fully replicates the Standard and Poor’s 500 (S&P 500) Index, a broad market index made up of the stocks of 500 large to medium-sized U.S. companies. The C Fund’s objective is to match the performance of the S&P 500. Also, some of the money in the C Fund is temporarily invested in the G Fund and earns the G Fund return.

The C Fund is a passively managed fund that remains invested according to its indexed investment strategy regardless of stock market movements or general economic conditions.

What is the Risk?

Your investment in the C Fund is subject to market risk because the prices of the stocks in the S&P 500 Index rise and fall. You are also exposed to inflation risk, meaning your C Fund investment may not grow enough to offset inflation.

What is the Benefit?

Historically, this increased risk has been rewarded with an increased return. It offers the opportunity to experience gains from equity ownership of large and mid-sized U.S. company stocks. Here is all the performance data as of 25 SEP 2019:

Screen Shot 2019-09-25 at 8.32.25 PM

Types of Earnings

The C Fund changes in value as the market price of its stocks change. In addition, the C Fund makes money for its investors when those stocks pay dividends. Unlike a traditional mutual fund, though, income from dividends is included in the share price calculation. It is not paid directly to participants’ accounts.

It also makes some money on interest on short-term investments and securities lending income.

BlackRock credits interest and dividend income each business day. This income is then reflected in the TSP share prices.

Share Price Calculations

The value of your account is determined each business day based on the daily share price and the number of shares you hold. At the end of each business day, after the stock and bond markets have closed, the total value of the funds’ holdings (net of accrued administrative expenses) is divided by the total number of shares outstanding to determine the share price for that day. The daily change in TSP share prices reflects all investment income (interest on short-term investments, dividends, capital gains or losses, and securities lending income) net of TSP administrative expenses.

Expenses

The net expenses paid by investors is 0.041% or 4.1 basis points, which like all the TSP funds is ridiculously low and is a major benefit of the TSP. It cost $0.41 for each $1,000 invested.

How Should I Use the C Fund in my TSP Account?

The C Fund can be useful in a portfolio that also contains stock funds that track other indexes such as the S Fund (which tracks an index of small US company stocks) and the I Fund (which tracks an index of international stocks). The C, S, and I Funds track different segments of the overall stock market without overlapping. This is important because the prices of stocks in each market segment don’t always move in the same direction or by the same amount at the same time. By investing in all segments of the stock market (as opposed to just one), you reduce your exposure to market risk.

The C Fund can also be useful in a portfolio that contains bonds. Again, it is because the prices of stocks and bonds don’t always move in the same direction or by the same amount at the same time. So a retirement portfolio that contains a bond fund like the F Fund, along with other stock funds, like the S and I Funds, will tend to be less volatile than one that contains stock funds alone.

Advice from My Favorite Short Investing Book

Here is what my favorite investing book, The Elements of Investing: Easy Lessons for Every Investor, says about S&P 500 index funds like the C Fund:

The best-known of the broad stock market mutual funds and Exchange Traded Funds (ETFs) in the US track the S&P 500 index of the largest stocks. We prefer using a broader index that includes more smaller-company stocks…Funds that track these broader indexes are often referred to as ‘total stock market’ index funds. More than 80 years of stock market history confirm that portfolios of smaller stocks have produced a higher rate of return than the return of the S&P 500 large-company index. While smaller companies are undoubtedly less stable and riskier that large firms, they are likely – on average – to produce somewhat higher future returns. Total stock market index funds are the better way for investors to benefit from the long-run growth of economic activity.

If you want to follow their advice, you just combine the C Fund with the S Fund in a 3:1 ratio. To see how I use the C Fund, read the Crush the TSP series.

Step 6 to Crush the TSP – Rebalance Annually

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We’ve talked about steps 1-5 to crush the Thrift Savings Plan (TSP). Now we move on to the final step (unless I think of more), step 6 – rebalance annually.

What is Rebalancing?

Let’s say that your desired TSP asset allocation is 70% stocks and 30% bonds. After the last year, though, stocks earned more than bonds and now you’re sitting at 85% stocks and 15% bonds. In order to rebalance back to your desired asset allocation, you’d sell approximately 15% of your stocks and buy bonds, restoring your desired asset allocation. It’s that simple.

Why Should You Rebalance?

If you don’t, you may be assuming more or less risk than you desire.

Also, by rebalancing you force yourself to sell what has overperformed and buy what has underperformed. Although this seems counter-intuitive because you are selling what has given you the largest return, by doing this you are systematically selling high and buying low. When left to themselves, investors typically buy high and sell low, the opposite of what you want to do. Rebalancing forces you to do it right.

How Often Should You Rebalance?

Vanguard has researched this, and you can read their full report here:

Best Practices for Portfolio Rebalancing

Their conclusion is:

We conclude that for most broadly diversified stock and bond fund portfolios (assuming reasonable expectations regarding return patterns, average returns, and risk), annual or semiannual monitoring, with rebalancing at 5% thresholds, is likely to produce a reasonable balance between risk control and cost minimization for most investors.

In other words, you rebalance annually or semiannually (twice per year) whenever your current asset allocations are off by 5% or more from your desired allocations. If the current and desired allocations are within 5% of each other, you do nothing.

How Do You Rebalance in the TSP?

You just log on and do what they call an “interfund transfer” or IFT. You can read all about it on this page from the TSP website.

Because you are doing it in a tax-advantaged retirement account, there are no expenses, fees, or taxes associated with rebalancing (unlike if you were rebalancing a taxable account).

You can only do it twice per month without restrictions, but since you are smart you are only doing it once per year anyway.

Do You Need to Rebalance With Lifecycle Funds?

No, you don’t. This is one of the major advantages of the L funds. If you are hitting the easy button on your TSP and just using a Lifecycle fund, you don’t need to rebalance…EVER!

That’s It. Crush the TSP!

That’s the final step to crush it in your TSP account. Read the whole series, maximize your TSP contributions, and get rich in the military.

Step 5 to Crush the TSP – Roth vs Traditional

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We’ve talked about steps 1-4 to crush the Thrift Savings Plan (TSP). Now we’re on to step 5, deciding between the Roth vs traditional TSP. Let’s take a look at the difference between the two and help you to decide which is the right choice for you.

The Traditional TSP

The traditional TSP is the first of two potential tax treatments for your TSP contributions. If you elect it, you defer paying taxes on your contributions and their earnings until you withdraw them. This is the only option for any money you get as a result of the 5% government match in the new Blended Retirement System (BRS).

If you are in a combat zone making tax-free contributions, your contributions will be tax-free at withdrawal but your earnings will be subject to tax.

The Roth TSP

The Roth TSP is the second of two potential tax treatments for your TSP contributions. If you contribute to it, you pay taxes on your contributions now and your earnings are tax-free at withdrawal.

The Roth TSP is similar to a Roth 401(k) that a civilian would have, not a Roth IRA. There are no income limits for Roth TSP contributions. You can contribute to both your Roth TSP and a Roth IRA without contributions to one affecting how much you can contribute to the other. For example, in 2019 you can contribute the full $19,000 to your Roth TSP and $6,000 to your Roth IRA.

Which One is Best for You?

Here’s a table that compares the two options from the TSP website:

The Treatment of… Traditional TSP Roth TSP
Contributions Pre-tax After-tax1
Your Paycheck Taxes are deferred*, so less money is taken out of your paycheck. Taxes are paid up front*, so more money comes out of your paycheck.
Transfers In Transfers allowed from eligible employer plans and traditional IRAs Transfers allowed from Roth 401(k)s, Roth 403(b)s, and Roth 457(b)s
Transfers Out Transfers allowed to eligible employer plans, traditional IRAs, and Roth IRAs2 Transfers allowed to Roth 401(k)s, Roth 403(b)s, Roth 457(b)s, and Roth IRAs3
Withdrawals Taxable when withdrawn Tax-free earnings if five years have passed since January 1 of the year you made your first Roth contribution, AND you are age 59½ or older, permanently disabled, or deceased

* If you are a member of the uniformed services receiving tax-exempt pay (i.e., pay that is subject to the combat zone tax exclusion), your contributions from that pay will also be tax-exempt.
1. Roth contributions are subject to Federal (and, where applicable, state and local) income taxes, while traditional contributions are not taxed until withdrawn. However, both Roth contributions and traditional contributions are included in the amount of wages used to calculate payroll taxes (e.g., Social Security taxes).
2. You would have to pay taxes on any pre-tax amount transferred to a Roth IRA.
3. Transfers to a Roth IRA from a Roth TSP are not subject to the income restrictions that apply to Roth IRA contributions.

The issue of whether Roth is a good option for you was discussed in this TSP Highlights called Is Roth For You?

If you are more of a visual learner, you might enjoy this video from the TSP called “Is Roth Right for Me?

If you like interactive calculators, this one from Betterment is pretty good.

If you don’t trust anything I say and want to read what someone else thinks, I don’t blame you. Here’s a good article from Money.

The decision really boils down to whether you’d like to pay taxes now (Roth) or later (traditional) and how your current tax rate compares to your likely future tax rate during retirement. While predicting the future is not easy, if you are young or early in your career, your earnings and tax rate are likely to rise in the future, so you should probably lean toward the Roth option. If you are in your peak earning years and you expect your tax rate to fall in retirement, you should probably lean toward the traditional and defer taxes to a future date.

If you are not sure which option to choose, many people recommend you diversify your retirement accounts and simply split the Roth and traditional 50/50. That way in the future you’ll have options depending on how future tax rates and your financial situation changes.

What do I do? I can afford the taxes now and want as much tax-free money available to me as I can get, so I put all the money in the Roth TSP that I can. That said, the first part of my career I didn’t have a Roth option, so a large percentage of my TSP balance is in the traditional TSP as well, so I’m about 50/50 split between the two options.

Some Rules to Be Aware Of

The TSP keeps your traditional and Roth money in separate “buckets” in your TSP account.

You cannot convert any portion of your existing traditional TSP balance to a Roth balance.

You can make both traditional and Roth contributions if you want. You can contribute in any percentages or amounts you choose and can change your election at any time.

If you are getting government contributions (perhaps because you are in the Blended Retirement System), they are deposited into your traditional TSP. You can put your portion in the Roth, but the government’s portion must go in the traditional.

The Bottom Line

Use the resources above to decide if you want to invest in the traditional TSP, the Roth TSP, or some combination of the two. If you’re not sure what to do, I’d just split it 50/50 so you have options in the future.

Keep your eye out for the last step to crush the TSP, rebalancing.