If you have investment accounts in addition to the Thrift Savings Plan, you have a choice: You can manage the TSP account on its own or as one piece of the bigger portfolio. Each approach has its pros and cons.
To illustrate, let’s assume you’ve developed and refined your financial plan and identified a balanced investment strategy of 60 percent, stocks; 35 percent, bonds; and 5 percent, cash. Let’s further assume that your TSP account balance is $50,000 and, in addition, you and your spouse each have $10,000 IRAs and a joint brokerage account containing $30,000 worth of securities — a total of $100,000 in investments.
You can choose to: Implement the balanced strategy independently in the TSP and each of the other accounts; or consider the entire portfolio as one and implement the strategy across the accounts.
The first — segregated — approach is simpler when it comes to calculating the allocation for each account and deciding what to buy or sell to achieve the target strategy. Let’s assume that in order to implement the balanced investment strategy in your TSP account, you’ll use all of the funds in the following proportions: 40 percent in the C Fund’s domestic large-cap stocks; 15 percent in the S Fund’s domestic small- and mid-cap stocks; 5 percent in the I Fund’s foreign stocks; 35 percent in F Fund’s bonds; and 5 percent in G Fund government securities, equivalent to cash. You simply instruct the plan administrator to rebalance your distribution to the target percentages. You can also instruct that any future contributions
be invested in the same proportions.
Implementing the strategy in the IRAs and joint brokerage account requires a little more arithmetic to convert the percentages to dollar and share amounts, but it is still relatively simple. In the joint brokerage account, for example, you would multiply the $30,000 account balance by each allocation percentage to determine the dollar amount to be invested in that asset class: 40 percent, or $12,000, to be invested in domestic large-cap stocks; 15 percent, or $4,500, to be invested in domestic small- and mid-cap stocks; $1,500 in foreign stocks; $10,500 in bonds; and $1,500 in cash. Then, choose the investment securities to represent each of the asset classes in the allocation and divide the target amounts by the current share prices to figure the number of shares of each security to buy.
For example, let’s say you’ve chosen to invest in Barclay’s iShares in the brokerage account. iShares are index funds that trade like stocks and have a number of advantages over mutual funds. They are similar in some ways to the TSP’s funds and offer low administrative expenses. Not a bad choice, in my opinion. The iShares S&P 500 index fund (symbol IVV), the equivalent of the C Fund, is currently trading at $122
per share. To use this as your proxy for domestic large-cap stocks, divide the $12,000 target allocation by $122 to determine that you’ll need to buy 98 shares of the fund in the brokerage account. Repeat this procedure for each of the other allocation target amounts. I’d consider IWM for the domestic small- and mid- cap proxy, EFA for the foreign stock, AGG for the bonds and a good money market fund for the cash.
You would then repeat this process for the two IRAs and any other investment accounts that were subject to the balanced investment strategy in your financial plan.
The second — integrated — approach is similar to the segregated approach, except that instead of applying the asset allocation to each account separately, you apply it to the aggregated value of all of the accounts. The advantages of this approach are that it minimizes transaction costs and allows for greater control of tax effects. Where transaction costs and taxes are an issue, the integrated approach will lead to higher net investment returns and greater investment success over the long term. Using the example, the domestic large-cap stock allocation would be equal to 40 percent of the $100,000 sum of the balances in the four accounts, or $40,000. You would then have to decide which account or accounts would best hold the $40,000 worth of large-cap stocks. You could decide to buy it all in the TSP account, using the C Fund. Or it could be split between the brokerage account and one of the IRAs. The possibilities for dividing the pie are endless.
While I prefer the integrated approach and use it exclusively in my practice, it is often too difficult and timeconsuming for the taste of do-it-yourself investors. For more than a few accounts, a spreadsheet or special software will be required to analyze the portfolio and rebalance the accounts. In my opinion, eitherapproach is acceptable and the additional costs inherent in the segregated approach should be manageable within the context of an overall financial plan.
Written by Mike Miles
For the Federal Times
Publication July 25, 2005