There are many people who wonder how the lifecycle funds in the Thrift Savings Plan (TSP) work, what it is, what its purpose is, and how it can benefit them. For someone new to investing, it is important to understand the space you are investing in and how to best utilize the funds available to you.
This article will help explain the basics of lifecycle funds and how you can make them work for you. This is written with the aim of helping the reader understand how to best use these types of funds in order to secure their financial future.
What Is a Lifecycle Fund?
In the investment space, there are a variety of different types of funds. These include index funds, mutual funds, exchange-traded funds (ETFs), and lifecycle funds. The lifecycle fund — also called a target-date fund — is an all-in-one fund that automatically rebalances and changes its asset allocation as the target date approaches. The goal of these types of funds is to provide investors with a simple and easy investment solution that will grow their money over time without having to worry about the day-to-day management of their portfolio.
It is also a perfect investment for those who don’t have the time to spend choosing and maintaining asset allocation for retirement plan portfolios. It acts as a diversified portfolio within a single fund that is set to automatically adjust as the target retirement date approaches. The lifecycle fund will gradually move from being mostly invested in stocks to being more conservative as the retirements are near. One of the most important things about the Lifecycle Funds is that they stick to a strict and rigid asset allocation.
How Do Lifecycle Funds Work?
As mentioned, lifecycle funds are a type of target-date retirement fund. They are based on an individual’s age and their expected retirement date. The fund will adjust its asset allocation over time to become more conservative as the investor approaches retirement. This allows investors to avoid making major changes to their portfolios in the lead-up to retirement, which is often when people sell stocks and other investments at the worst possible time.
Suppose you invest in a lifecycle fund with a target date of 2050 in 2020. The fund’s asset allocation will be very different in 2020 than it will be in 2030, 2040, and 2050. In 2020, the asset allocation will be more aggressive because there are longer time horizons and more time for the investments to grow. As 2030 approaches, the asset allocation will become more conservative because there is less time for the investments to grow. As the retirement or the target date approaches, the fund will be mostly in cash and bonds.
Why Would I Invest In a Lifecycle Fund?
A lifecycle fund is an investment, thus, you can reap benefits from it. For someone or an investor that has a targeted need for a specific amount of capital for a specific date in the future, this type of fund would be beneficial. It is convenient as it is an all-in-one fund, which means that it is a one-stop shop for retirement investing. It is more like an autopilot for all your investing activities. For those who are more in a passive approach on the retirement front, this type of fund would work best as you do not have to worry about day-to-day management and it automatically rebalances.
Another reason to consider investing in a lifecycle fund is that it is less risky. Called the Glide Path to Retirement, lifecycle funds have a set asset allocation that becomes more conservative as the target date approaches. This will protect your investment and allow it to grow over time without the worry of having to make major changes yourself. As it shifts allocations, the risk is spread out and protects you from making bad decisions.
What Are The Risks Of Investing In A Lifecycle Fund?
Just like any other investment, there are always risks when you put your money in. But before that let’s go through the two main attributes of L funds, or the Lifecycle Funds.
- They are simple and easy — The lifecycle fund is made to simplify TSP investing and allow federal employees to invest and have all their money in one place. As federal employees approach retirement, the lifecycle fund will automatically rebalance and adjust to a more conservative asset allocation.
- Better default option — The TSP offers a number of different investment options, but the L Funds are often considered the best default option for most employees. Before, it was the G fund but as time changed and with a more improved market, the L funds became the best and most recommended default option. It is applicable for new hires and for employees who do not want to actively manage their TSP accounts.
Risks and Downside
The main risk when it comes to L Funds is that you’re giving up control of your money to someone else. When you invest in an L Fund, you’re trusting that the fund managers will make the best decisions for your money. This isn’t always the case, and there have been times when L Funds have lost money. Another thing is for your federal employees that don’t really need to invest aggressively, the L funds may not be the best option as it will still have that allocation.
Another thing worth mentioning is the types of securities held by each of the underlying funds in the L Fund. Funds that hold common stocks are subject to market risk, which is the chance that stock prices overall will decline in the short term. Not to mention the fees and other expenses associated with underlying funds will reduce the returns of the L Fund.
How to Choose a Lifecycle Fund
The TSP offers a number of different fund options for investors to choose from, with each having its own purpose and requirements. The most popular option is the lifecycle fund, which allows you to choose how conservative or risky you would like your investment mix to be. You can also choose between the L Income, L 2020, L 2030, L 2040, and L 2050 funds (the last one being the most conservative). However, if you want to invest in a specific type of asset class or strategy, then you will need to look at other options available in the TSP.
Make sure to consider the lifecycle fund that you are most comfortable with. As mentioned earlier, the L Income Fund is the most conservative while the L 2050 fund is the most aggressive. If you’re closer to retirement, then you will want to choose a fund that is more conservative. On the other hand, if you’re just starting out, then you can afford to take on more risk. Remember that like any mutual fund, the value of your investment will go up and down over time. Thus, the value of your principal investment may be higher or lower when you actually retire.
TSP’s Five Basic Investment Options
To better grasp the idea and how L funds work, let’s take a look at the five basic investment options in the TSP.
The G Fund: Government Securities Investment Fund
The G fund is made up of special-issue Treasury securities that are backed by the full faith and credit of the U.S. government. These securities are known as government securities. The G fund is the only investment option in the TSP that is not subject to market risk, which is the chance that stock prices overall will decline in the short term. Also, it is the one TSP fund that guarantees the return of the investor’s principal and is seen as the fund with the lowest risk. It pays an interest based on the average yield of all outstanding Treasury notes and bonds with maturities of days to 52 weeks.
The F Fund: Fixed Income Index Investment Fund
A more diversified bond portfolio with assets including government, corporate, and mortgage-backed bonds. The F Fund also pays monthly interest that is higher than the G Fund. The F fund is more volatile than the G fund, but its returns have been higher over time. Also, this fund does not guarantee the return of your principal.
The C Fund: Common Stock Index Investment Fund
The C Fund is made up of stocks of large and medium-sized U.S. companies. It tracks the Standard & Poor’s 500 Index, which is a market-weighted index of 500 stocks. The C Fund pays dividends quarterly and capital gains annually. Over the long run, the C Fund has provided higher returns than the G and F Funds, but it is also more volatile in the short term. It offers little income but provides a better potential for capital appreciation.
The S Fund: Small Cap Stock Index Investment Fund
The S fund is made up of stocks of small and mid-sized U.S. companies. Companies that fall into the small-cap category usually have market caps of $2 billion or less. The S fund tracks the particular market index including S&P 500 companies. The S Fund capitalizes on the growth potential of small-cap stocks, which have outperformed large-cap stocks over long periods of time. Just like C Fund, S Fund offers little income but provides a better potential for capital appreciation.
The I Fund: International Stock Index Investment Fund
The I Fund is made up of a mix of stocks from developed and emerging markets outside the U.S. The I Fund provides diversification and the opportunity to participate in the growth of international economies. While it has the potential for higher returns than the G, F, and C Funds, it also carries more risk. It is subjected to stock market risk, country/regional risk, currency risk, investment style, and emerging markets risk.
Now that you understand a little of how lifecycle funds work, let’s take a look at the asset allocation for each fund. Asset allocation is the process of deciding how to invest your money among different asset classes, such as stocks, bonds, and cash. Asset allocation is what makes your portfolio diversified and helps to protect you from risk.
Many people opt to do their own asset allocation and choose whatever funds they want. However, this can be a difficult and time-consuming process. It’s also easy to make mistakes that can cost you money. For TSP lifecycle funds, asset allocation is made based on your age and investment goals.
How Often Do TSP Lifecycle Funds Rebalance?
The default investment option for the Thrift Savings Plan (TSP) is the lifecycle Funds. The five lifecycle funds are offered to invest in a mix of underlying TSP funds, and they are designed to become more conservative as participants approach retirement.
The target allocations for each lifecycle fund, except L income, are reviewed and rebalanced quarterly or every three months. Remember that the L fund has the same risks as any of the five core TSP funds. That means if any allocations experience loss or underperformance, you can expect the L fund to experience the same.
As it stands, the TSP lifecycle funds are a great option for many federal employees and military members. If you’re someone who doesn’t want to spend a lot of time managing your investments, these funds can be a good solution. They offer diversification and rebalance automatically to keep you on track.
If you’re someone who likes to have more control over your investments, you might want to consider other options. To know if TSP lifecycle Funds are right for you, then consider working with a financial advisor to help you make the best decision for your unique situation. My Federal Plan’s network of licensed agents has been working with government employees exclusively for years and can help you plan your retirement. Schedule a retirement plan consultation with us and learn how we can help you.