The Good and Bad of Lifecycle FundsFederal Employees
Lifecycle funds were introduced to federal employees in 2005. They use a mix of the five funds available in the Thrift Savings Plan designed around a target date. Although they have been around for over a decade, there is still a fair amount of misunderstanding involving the Lifecycle funds.
What are they?
Per tsp.gov, “The L Funds, or "Lifecycle" funds, use professionally determined investment mixes that are tailored to meet investment objectives based on various time horizons. The objective is to strike an optimal balance between the expected risk and return associated with each fund.”
The most conservative Lifecycle fund is L Income and the most aggressive is L 2050.
- L income
- 80% G and F funds (fixed income)
- 20% C, S, and I funds (stocks)
- L 2050
- 17% G and F funds
- 83% C, S and I funds
Each quarter, the L funds target allocation changes (except for L Income), moving more money from the stock funds into the fixed income funds; making employee’s investments a little more conservative every quarter. The closer we get to the target date, the more conservative the allocation becomes.
Who are Lifecycle (or Target date) funds for?
Lifecycle funds are for employees who:
- Aren’t very investment savvy
- Do their own investing
- Want to take a diversified approach
- Want to become more conservative every quarter
These are the characteristics of employees that I believe will benefit most by using the Lifecycle funds. If you find yourself is this category, the path of least resistance is to invest your TSP dollars in a Lifecycle fund. They will provide you with adequate diversification and there is no need to continually monitor them.
Caution: be careful picking a time horizon.
Most people that I see buying Lifecycle funds, buy them based on their retirement date. For example, if you plan to retire in 2030, then the TSP website recommends you buy the 2030 Lifecycle fund. If you follow that advice, you will have 80% of your money in fixed income at retirement, but is that what you want? Or a better question is: should you have 80% of your money in fixed income at retirement?
Since most people’s goal with their TSP is to provide retirement income, we should probably look at retirement income studies for advice. Most retirement income studies use an allocation of 50-60% in stocks and the balance in fixed income. The reason they use that allocation is twofold:
- The 50% in fixed income brings better stability to the portfolio vs having all stocks
- The 50% in stocks give the portfolio earning power and a better chance to outperform inflation and taxes than fixed income.
Put in simpler terms, a 50/50 or even 60/40 portfolio has proven over time to be able to sustain significantly higher withdrawal rates than a portfolio with 80% in fixed income.
A retirement date does not and should not equal an automatic 80% allocation to fixed income. If you will rely on income from your TSP in retirement, then you may want to take more risk in your TSP (many retirement studies say that you should). The longer you expect your retirement to be, the longer the time period is that you need your investments to keep up with inflation and taxes. Stocks, historically speaking, give you a much better chance to combat inflation than fixed income does.
Another reason not to have 80% in fixed income.
In a previous article, I discussed the relationship of federal employees’ FERS annuity with the TSP. Federal employee retirement income is designed to come from three sources:
- FERS annuity
- Social Security
- Thrift Savings Plan
The FERS annuity and Social Security are guaranteed payments that also have cost of living increases built into them. So, if a federal employee looked at their entire allocation, they would have to classify those two income sources as fixed income. If 2/3 of your income is guaranteed, then you can afford to take more risk with the other 1/3.
How to implement lifecycle funds.
As I mentioned above, the Lifecycle funds can be a good fit for the do it yourselfer. My main concern with the Lifecycle funds is the misunderstanding around the time horizon.
Now that you have a better understanding of Lifecycle funds, you can use that to your advantage. If you plan to retire in 2030, but don’t want to have 80% of your investments in fixed income, then use the 2040 or 2050 Lifecycle fund. Choosing one of the longer time horizons will put more of your dollars in the stock funds and provide good diversification.
Before investing in your TSP please take the time to learn more about your choices. Investing in TSP is an integral part of every federal employee's retirement plan. If you would like to discuss setting up a retirement plan you are welcome to schedule a time to talk.
Brad Bobb, CFP® is the owner of Bobb Financial Inc, and an expert in retirement planning for federal employees.