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The Thrift Savings Plan: What’s Missing?


Old combat vets know: Don’t bunch up. Don’t put all your leaders on the same helicopter. Don’t put all your ammo on the same truck. And don’t stand around in groups of people so tight you can all be taken out by the same grenade.

The same goes for investing. Diversification is a good thing. Don’t put all your eggs in one basket. And even when you spread things around a bit, don’t put your eggs in a few different baskets that are all likely to drop at the same time.

All service members are eligible to contribute to the TSP, or thrift savings plan – a sort of 401(k) for federal employees. Your contributions come pre-tax, and grow tax deferred until you start pulling money out in retirement. There’s no income tax on the money, or capital gains tax. You can transfer money from one account in the TSP to another without incurring a federal tax liability.

The TSP doesn’t provide employer matching funds, like many civilian 401(k) plans. But for straight ahead large cap, small cap, fixed income, government bonds and broad international stocks, the TSP does these things exceptionally well. You will be hard-pressed to find a more competitively priced investing option. And if you choose an L-fund, you will be instantly diversified among all these important asset classes.

But the TSP is not, as Sarah Palin might say, the “end-all, be-all” of retirement investing. From the point of view of diversification, there are a number of important asset classes that are wholly unrepresented in your TSP – but which you might want to consider holding elsewhere in your portfolio.

Real Estate

The thrift savings plan gives you no way to hold real estate directly. If you own a home, though, you already have some exposure to this important asset class. If not, you can buy funds and index funds that specialize in REITs. The term REIT stands for “Real Estate Investment Trust.” These are large commercial or residential landholders or developers that own real estate, sell when they can at a profit, and collect rent. By law, REITs must forward at least 90 percent of the income they realize each year to their shareholders. REITs and REIT funds therefore tend to kick off income in the form of dividends.

If you hold REITs outside of an IRA or similarly tax-advantaged retirement account, that income is taxable to you on your individual income tax return – usually at the preferred qualified income tax rate for dividends from U.S.-based companies. If you hold it in a traditional IRA it’s tax deferred, just like your TSP. If you hold it in Roth IRA it’s tax free, forever.

Real Estate can be a boon to your portfolio not because it always generates positive returns. We know from the last four years that real estate can lose money just as any other asset class. But real estate historically has been an effective diversifier against the asset classes in your TSP. Stocks and real estate often move in opposite directions – negating each other’s volatility to some extent, but preserving the long term returns of both.

Gold and Precious Metals

Gold has been an effective and reliable store of wealth and value for thousands of years. It generates no wealth of its own, and does not kick out an income. What it does, do, however, is hold its value or increase in value just as everything else in your portfolio is collapsing. Gold tends to do well during times of economic uncertainty, war, chaos and disorder, and where faith in the dollar is eroding. Gold is considered very inflation-proof, and in some ways is the ultimate hedge against inflation. In recent years, gold and other precious metals have done extremely well amidst the general economic deterioration from 2007 through 2011 and beyond. Standard & Poor’s downgraded U.S. debt last summer because they had less faith in the government’s ability to deal with the national debt or shore up the dollar in any meaningful way. Meanwhile, the Federal Reserve was creating money out of thin air trying to prop up the economy and stave off a deflationary cycle like it was going out of style – a historic recipe for inflation down the road.

TIPS

TIPS stands for Treasury Inflation-Protected Securities. These are treasury bonds that automatically adjust themselves to keep up with the cost of living. If you stay in the military and retire after 20 years, you do have some inflation protection built-in to the military pension: You get a COLA adjustment every so often, based on the rate of inflation. If you don’t retire from the military, though, you have to do your own inflation hedging. TIPS are a very secure way to do just that.

Emerging Markets

Emerging markets are fast-growing but as-yet undeveloped or underdeveloped countries that are characterized by cheap labor – which is attractive to manufacturers – high population growth and relatively young populations, and generally rapid economic growth. Of course, emerging markets can be subject to severe recessions, economic uncertainty and political chaos, as well. However, on the whole, emerging markets in places like India, China, Thailand, Singapore, Indonesia, and parts of Eastern Europe and even Africa are growing much faster than the more developed economies in the U.S. and Europe. Yes, the TSP’s international fund provides some exposure to some of these markets. But some aggressive investors may prefer a more concentrated emerging markets position. The combination of high growth potential and low correlation with the U.S and European stock markets make emerging markets an excellent diversifier.

Again, it’s very easy to get a broad exposure to emerging markets by buying an emerging markets index fund from a reputable low-cost, no-load mutual fund company, such as Vanguard, Fidelity or T. Rowe Price, to name a few. If you’re a USAA client, USAA has an emerging markets fund, as well. It’s actively-managed, so it’s not an index fund. Their managers charge a much higher expense ratio (currently 1.64 percent of assets, compared to the Vanguard Emerging Markets Stock Index Fund), but they work to beat the market while minimizing risks. Sometimes they succeed, sometimes not. However, you should still get most of the benefit of diversification and economic growth in emerging markets with this fund, as well. Just be prepared for a bumpy ride!

Summary

Each of these asset classes is a useful diversifier against the asset mix available in the Thrift Savings Plan. And if you hold them in a Roth IRA, you also achieve the objective of gaining some tax diversification as well: Roth IRAs are taxed the opposite of the TSP. That is, you pay your taxes on the Roth IRA now, and you get no deduction for contributions. But there is no tax due ever again on Roth IRA assets, provided you hold the assets in your Roth for at least 5 years. If Congress increases taxes before you retire, owning a Roth helps you soften the blow – at least somewhat.

The main thing you can do is this: Contribute. Start early, and contribute often to your TSP, your IRA, your permanent life insurance plan, if you choose one, and to your private savings. Diversify among many assets and asset classes. Don’t put all your eggs in one basket.

By Jason Van Steenwyk

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