The Best TSP Investment Strategy Out There

I’m sharing several options for investing in the TSP.

The Thrift Savings Plan is a defined contribution plan for United States civil service employees and retirees as well as for members of the uniformed services.

It is essentially like a 401K for military and civil service employees.

I’m not here to tell you which TSP recommendation is best, that’s a fool’s errand.

The only way to do that is to go into the future, see how things turn out, and then tell you which TSP asset allocation would have been ideal.

I will, however, give you the tools to make an informed decision about the best TSP investment methods.

Most of these TSP investments strategies should work well if you regularly contribute to your thrift savings plan, ensure you are getting matching if it’s offered, and stick with the same strategy over the long term.

I would caution against jumping back and forth between investment strategies every time you find something bright and shiny.  Many people erode their long term returns by “dancing in and out of the market.” (Warren Buffett)

First, it’s important to understand the five core funds inside the TSP and what they consist of.  This is important in understanding how they are used in building TSP investment portfolios.

THE FIVE CORE FUNDS PLUS L

  • The G fund contains short term U.S. Treasury securities with no exposure to the risk of the bond or stock market

  • The F fund is an index of world-wide government, corporate, and mortgage-backed bonds

  • The C fund is equivalent to the S&P 500 index.

  • The S fund is an index of mid and small-cap stocks not included in the S&P 500.

  • The I fund mimics the MSCI EAFE Index of international stocks in 21 developed markets excluding the United States and Canada.

  • The L funds are professionally managed investment funds tailored to a specific time horizon.

Now we dive into each one a little more in depth before going into our TSP investment strategies:

The G fund – The Government Security Investment Fund

Pros: No volatility and backed by full faith and credit of the U.S. government

Cons:  Can barely match the inflation rate; rate based on prevailing interest rate, which is currently low

This unique investment is only available to TSP investors.  It’s rate is equal to 10-year treasuries, but their liquidity and protection from interest rate fluctuations is superior to 3-month T-bills.

The interest rate resets monthly and is based on the average of U.S. treasuries with a duration of 4 year or more.

The F fund – The Fixed Income Investment Fund

Pros:  Low volatility; historically outperforms G fund

Cons:  Currently has low returns as based on prevailing interest rate; loses value if interest rates rise sharply

This fund follows the Bloomberg Barclays U.S. Aggregate Bond Index, which invests in government and corporate bonds as well as mortgage-backed securities.  That means this fund holds some U.S. treasuries, which means it has some overlap with the G fund.

The returns on this fund are historically slightly higher and slightly more volatile than the G fund.

The F fund tends to be superior when interest rates are flat or falling.  If interest rates are rising, it is safer to have money in the G fund.

The C Fund – The Common Stock Index Investment Fund

Pros:  Historically has returned around 7-9% over the long term, depending on who you ask, and how you calculate.

Cons:  Can have decade long periods without gains; falls with crashes and bubbles

This fund follows the S&P 500 index, which is an index of the 500 largest and most profitable U.S. corporations.

Even though there are 500 companies in the index, the top 10 companies, which consist of big names like Apple, Google, Microsoft, and Amazon, make up 20% of the value of the fund.

The S Fund – The Small Capitalization Stock Index Investment Fund

Pros:  Similar returns to the C fund, but with more diversification

Cons:  Can have decade long periods without gains; falls with crashes and bubbles

This fund has mid and small cap stocks, making up the rest of the stocks in the market other than what is in the S&P 500 index.  This fund seeks to match the performance of the Dow Jones U.S. Completion Total Stock Market Index.  It consists of about 3300 stocks.

The I fund – The International Stock Index Investment Fund

Pros:  Allows for international equities to be purchased

Cons:  Only invested in developed countries, so lacks exposure to entire international market and emerging markets

This fund mimics the MSCI EAFE (Europe, Australasia, and Far East) Index, a collection of over 900 large and medium sized corporations.  Most of these companies are in Western Europe and Japan.

Keep in mind, this fund is concentrated primarily in Japan, Germany, Switzerland, France, and the UK.  Japan makes up more than 25% of the portfolio.  It is not the same as some international funds out there that have a sampling of small companies from countries all over the world.

This is actually an important consideration when equating this I fund with some of the TSP investment strategies I have listed later in this post.

When strategies call for an international index fund, they probably mean a international index fund with exposure to emerging countries and smaller  companies as well as the ones listed in the MSCI EAFE.  There are different flavors of international index funds, and this I fund doesn’t quite capture the most diverse of them.

Keep that in mind when using the I fund as a substitute for international index funds in a prescribed strategy.

The L funds – Lifecycle Funds

Pros:  Asset allocation and rebalancing is done for you by BlackRock, which is one of the most respected investment firms in the world with $6.3 trillion under management.

Cons:  You have no control over your asset allocation; some say the fund is conservative

The L funds, which stands for Lifecycle funds, use professionally determined investment mixes.  You choose the L fund that matches the timeframe you plan you start needing the money in your TSP.

Currently, the L funds offered are L2020, L2030, L2040, and L2050.  If you were to choose the L2040 fund, this fund would be optimized for beginning withdrawals in the year 2040.

Using the 2040 L fund as an example, if you were to invest in it in January of 2019, it would have the following asset allocation:

TSP allocation

from TSP.gov

As you can see, roughly 28% are invested in the G an F funds, which are essentially treasuries and bonds.  The rest is divided up between the C, S, and I funds, which are invested in the stock market which is more volatile.

This is BlackRock’s recommendation for an appropriate balance between stocks and bonds to mitigate the volatility of the portfolio.  When the stock market crashes by 40% in a month, this portfolio would go down less due to being invested 29% in treasuries and bonds.

The converse, however, is also true.  If the stock market goes up 40% in 2 months, this portfolio will go up less than that, because of the investment in less risky treasuries and bonds.

The funds allocation is adjusted quarterly to slowly move towards a much more conservative portfolio by 2040 that will at that point turn into the L Income fund which has the following asset allocation that does not change:

TSP allocation strategies

from TSP.gov

 

Ignore the date October 2018 on this graphic.  This will be the asset allocation in 2040 for the L 2040 fund once it matures and becomes the L income fund.

So essentially what happens with L funds is they move from being more risky to more conservative over time, ending with the L income fund, which is how the investment stays while you are actually withdrawing from it in your older years.

It the case of the L 2040 fund, it moves from the allocation in the first graphic above to the second. Quarterly reallocating the investment gradually from roughly 28% to 80% invested in treasuries and bonds.

Investment Allocation Strategies for Your TSP

Below is a list of different potential TSP asset allocations you could use.  I’ve pulled these from various sources and as I discover new ones, I will update this.  Please send me your recommendations with supported documentation.

The S&P 500 Index

This is the asset allocation I used most of my working life.

When I opened a Roth IRA in 1999, I called my bank and asked to put it in the S&P 500.  At the urging of an investment advisor (I’m not a fan), I put it in an aggressive growth fund instead.  In 2000, it lost half its value.

From that day forward, I decided S&P 500 would be the way I invest.  I had read before that Warren Buffett said something to the effect of, if you don’t have time to look at stock charts and read finance news all day long, you are better off investing in the S&P 500 index and never touching it.

Actually, here’s exactly what he said in 2013 in his letter to shareholders:

“Most investors, of course, have not made the study of business prospects a priority in their lives. If wise, they will conclude that they do not know enough about specific businesses to predict their future earning power…I have good news for these non-professionals: The typical investor doesn’t need this skill…In the 20th Century, the Dow Jones Industrials index advanced from 66 to 11,497, paying a rising stream of dividends to boot. The 21st Century will witness further gains, almost certain to be substantial. The goal of the non-professional should not be to pick winners…but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal.”

Additionally, instead of investing his wife’s inheritance in Berkshire Hathaway stock, he plans to invest it in the S&P 500 index.

That should tell you something.

If it’s good enough for Warren, it’s good enough for me.

To mimic a full investment in the S&P 500 index, just invest 100% in the C fund.

The Total Stock Market Index

This investment choice is a popular one and is the main recommendation of JL Collins on his blog www.jlcollinsnh.com and in his book The Simple Path to Wealth.

Instead of just investing in the largest companies that make up the S&P 500, you invest in those plus mid and small cap companies as well.  This index encompasses the entire U.S. stock market (as the name suggests!)

Financial Independence Retire Early (FIRE) enthusiasts will swear to the superiority of this index to the S&P 500, and suggesting considering anything else is heresy!

It’s clearly more diversified than the S&P 500, and small caps tend to outperform large caps over the long term, albeit with potentially a little more volatility.

Over long periods of time, the total stock market index fund and S&P 500 had similar performance, and it would be hard to say for sure which will outperform in the future.

In my opinion, you are doing great with either one.

80% C and 20% S will closely mimic this popular index.

The Warren Buffett TSP Allocation

While I mentioned earlier I got my idea for an all S&P 500 index allocation from something Warren Buffett said in a newsletter, he actually has more specific instructions I want to address here.

I talked earlier about how he had a plan for how the money left for his wife would be invested.  I said he would invest in S&P 500 index instead of Berkshire Hathaway, but that’s only part of the story.

He also has a plan to throw bonds into the mix to smooth out the ride a little bit, which is a common investment strategy.  The amount of bonds you throw into the mix will dampen the volatility, but will also limit your upside potential during booms as well.

In the same newsletter in 2013, he talked about his specific advice to his trustee on how to invest the remaining money that will be left to his family:

“My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund…I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.”

As luck would have it, this is easy to mimic with the funds offered in the thrift savings plan.  90% C fund and 10% F fund.

Thanks Warren!

Dave Ramsey’s 2 TSP Investment Recommendations

I’m a huge fan of Dave’s book Total Money Makeover.  His baby steps for getting out of debt are legendary!

He also has recommendations on how to invest in the thrift savings plan.  His caveats are typical of Dave’s approach to money.

In typical Dave fashion, he suggests that you first pay off all your debt besides your primary residence before you begin long term investing and have an emergency fund of three to six months of expenses as well.

He has two sets of recommendations.  One slightly more aggressive than the other.

More conservative:  80% in C, 10% in S, 10% in I.

Less conservative:  60% in C, 20% in S, 20% in I.

Here is the link to his recommendation.

Paul Merriman’s 3 TSP Investment Recommendations

Paul Merriman is a successful advisor on mutual funds and index fund investing.  He’s an accomplished author, speaker, and is well known for then ultimate buy-and-hold portfolio.

This portfolio is comprised of index funds and has an amazing track record.  Unfortunately, due to the various types of funds held in this portfolio, it is impossible to mimic with the S&P 500.

If you are curious, I wrote an article about this how to invest in this portfolio:

9 Proven Ways to Boost Your Index Fund Returns

He explains that most notably what is missing from the TSP funds is value funds, which is a key component of his strategy to boost typical index fund returns.

He does make specific recommendations for TSP owners using what is available in that family of funds.

He has 3 separate recommendations based on your risk tolerance, conservative, moderate and aggressive.

With all three of these portfolios, the equity part of the portfolio is split the same way:

50% in S, 25% in C, 25% in I.

With the aggressive portfolio, the entire amount is invested this way.  The conservative and moderate portfolios have a portion of the total invested in the F and G funds.  This portion is not exposed to the risk of the stock market, as the C, S and I funds are.

His advice is that, generally, younger investors can afford to be more aggressive, and as you get older, you become more conservative, but this is a generalization and everybody’s situation may differ.

The conservative portfolio is 60% G and F, and the rest in S, C and I at 50/25/25.

The moderate portfolio is 40% G and F, and the rest in S, C and I at 50/25/25.

Attached is a graphic from his website outlining exactly how to do this strategy.

TSP investment strategies

From www.paulmerriman.com/tsp/

Here is the link to his article on TSP recommendations:

How to pick smarter investments in your U.S. Thrift Savings Plans

Total World Stock Market Portfolio

This portfolio mix is modeled loosely after the Vanguard Total World Stock Index Fund (VTWSX).

It will allow you to have exposure to stock markets around the globe, including the United States and developed foreign markets.

The weakness of this portfolio compared to the Vanguard one is it has exposure to emerging markets.  The I fund currently only has developed economies, and not emerging markets.  There actually is a plan in place to change the I fund in the future to include emerging markets, but it hasn’t happened yet.

The Vanguard fund I am modeling after has roughly 60% of the portfolio in U.S. stocks, and the rest are international.  To model this portfolio, use 48% C and 12% S to make up the U.S. stock market, then use 40% I for the rest.

The 48/12 mix comes from splitting 60% into an 80/20 mix to achieve the Total Stock Market Index.

Balanced Index Fund Portfolio

This portfolio is meant to mimic the Vanguard Balanced Index Fund Admiral Shares (VBIAX).

It is a way to have access to the entire U.S. stock and bond market.  It has far less volatility than the Total Stock Market Index by using bonds to smooth out the ride.  The balance of this portfolio is 60% stocks, and 40% bonds.

This can be accomplished through 48% C, 12% S, and 40% F.

Obviously, you could adjust the stock/bond ratio to meet any level of risk that you would like.

Three Fund Portfolio

This is a favorite among Bogleheads (Those who love Vanguard and its founder Jack Bogle).

This fund is comprised of 1/3 each of the following:

Vanguard Total Stock Market Fund

Vanguard Total International Stock Market Fund

Vanguard Total Bond Market Fund

This fund is broadly diversified, but heavily weighted in large cap stocks.  Remember, the I fund lacks the exposure to emerging markets that the Total International Stock Market Fund has, so the thrift savings plan version won’t be identical until the I includes more countries and emerging markets.

To mimic the Total Stock Market fund, I split the 33% in an 80/20 C/S split.  This is where I get my weird percentages from.

A way to closely mimic this portfolio is: 27% C, 7% S, 33% I, 33% F.

There you have it.

If you have a recommendation for additional investment allocations or strategies for the TSP, comment or email them in.

I’ll keep this updated.

Inspiration for this post came from one of my favorite posts of all time, the White Coat Investor’s compilation of 150 Portfolios Better than Yours.

An awesome resource for TSP info I found in researching this post was Lyn Alden’s TSP: The Ultimate Guide for 2019.

What are you doing in your TSP?  How has it worked out for you?

Let me know in the comments!

Be sure to read my post The 10 Cheapest Index Funds to Supercharge your Portfolio

Rich on Money

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8 Comments

  1. Avatar

    Todd

    Hi Rich, Happy New Year-

    The TSP wasn’t offered when I was a young enlisted soldier, and I don’t know if I would have seen the wisdom of socking money away for ‘retirement’ at that age (?).

    I did manage to save-off $500/mo that went into a savings account (‘..back home..’), and I was always impressed with how well that pile of cash grew.

    I never missed the money – as it came off the top so quickly – I didn’t have time to do so! I also didn’t spend any of the money, as it was direct deposited and then “directly transferred” into said savings account.

    Not to mention that my bank was approximately 9,300 mi from my duty station…

    Thank you for the post, as I enjoyed reading about the TSP and seeing that Uncle Sam is offering an opportunity for his children to grow their wealth: Hoo-Yah!

    I’d be interested to hear what your thoughts are about the education-piece (at the soldier-level) that Uncle offers?

    I recall many of my peers having a lack of financial acumen and that it was (often) difficult to explain the most-basic-of-concepts (ie; income v outflow, direct deposit, use of a checkbook, contributing to the GI Bill, etc). This wasn’t necessarily their fault, as many of these young people had little / no ‘financial education’ or were only accustomed to the modeling of poor financial habits by their family and / or peers.

    I certainly hope that investing-education is offered and encouraged among the rank and file (?).

    As you noted, I’d also give a shout-out to your readers about ‘The Simple Path to Wealth’. I found the book to be one of the best on the topic of saving for one’s retirement, and written in such a way that it was easy to understand without being preachy or overly simplistic.

    I hope the New Year is treating you well, Rich, and I look forward to many more engaging posts from your blog!

    Cheers ~ Todd

    • Avatar

      Of course the education piece is important, albeit not a large focus subject on my blog.

      I have done the paperwork to transfer to the post 911 gi bill and set it up so my children can use it when I retire.

      I’m not sure if you’re familiar with Doug Nordman and the-military-guide, but it’s got some great articles for helping military members and vets.

      Here’s one about the G.I. Bill.

      https://the-military-guide.com/gi-bill-terrible-thing-waste/

  2. Avatar

    Max

    Rich,
    I am a young sailor trying to get this TSP thing right. Im proud that i was smart enough as an 18 y/o boot to contribute to TSP and get my money out of the G fund and into L2050. I titrated my monthly contributions to 30% base pay by the time I was 8 months in. 6 years later I’m relatively happy where I’m at, but have gotten more and more mindful of whats actually happening with my money.

    At this point I’m a little scared to leave the comfort of having someone else manage my investments but also dont see why i wouldnt align my accounts to reflect the views of someone like Warren Buffet. I just made the move to transfer current and future funds as follows
    C:75%
    F:5%
    L:20%

    I’ll be honest, it was a bit of an impulse move. For some reason though, keeping some of the money with L fund just made me feel comfortable that someones adjusting for the market. Do you see anything terribly wrong with this thought?
    Thanks in advance,
    R/
    Max

    • Avatar

      If I knew the future, I’d tell you exactly how to invest. I don’t know.
      I don’t see anything terribly wrong with what you are doing. Good luck. It sounds like you’re doing well.

  3. Avatar

    sean

    great post! It’s really helpful to think about TSP the way you have broken down. It was really helpful to read your post with post from Lyn Alden’s TSP: The Ultimate Guide for 2019. I’m definitely deciding between few of the strategies you have listed.

    But one caveat is something I learned from Lyn Alden’s post on I fund which I didn’t look carefully at. You do address this about the I fund, but I believe some of your strategies seems to equate total international stock fund with I fund, which is probably inaccurate? What do you think?

  4. Avatar

    Mike P.

    Thanks for the straight-forward and fact-based article on TSP funds.
    I’m a long-time federal employee. My payroll contributions are allocated as follows: 60%/10%/30% to the C, F, and G funds, respectively.
    The current value of my account is 75% in C, 7% in I, and 18% in G. Mostly out of neglect, it seems to have performed well over the long term, but I’ve been meaning to update my allocation to be more conservative 😉 So your article will be a great resource for that. Thanks again.
    Mostly out of neglect, my fund has done well.

    • Avatar

      I appreciate the comment. That’s good information. I’d like to encourage others to share what they are doing so people can compare and make their own informed decisions or tweaks.

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