At the end of July, the Thrift Savings Plan L Funds completed their first full year. The L Funds, or lifestyle funds, are combinations of the other five TSP funds — the G, F, C, S and I funds. Participants pick their funds based on the year when they expect to need to withdraw the money: 2040, 2030, 2020, 2010 or in the near future. Each of the five L Funds produces a different risk and return profile, ranging from aggressive to conservative.

The L Funds are professionally managed funds designed to capitalize on the benefits of investment diversification — producing greater risk-adjusted returns than what would be possible using any of the individual TSP funds alone. TSP promises that investors can invest in an L Fund and leave it on autopilot — the fund managers do the heavy lifting of adjusting investments to meet performance goals.

It is tempting to look at recent performance and judge the funds based on their absolute or relative returns. Like a field of Triple Crown racehorses, the L Funds are a product of good breeding. They have the best of each of the other funds and are carefully managed. In theory, they should all cross the finish line as winners.

As expected, the L 2040 Fund is the most aggressive, since it has the longest maturity time. The L Income Fund is the most conservative of the group because it has been designed for participants looking to retire in the short term. However, the risk and return profile for all but the L Income Fund becomes more conservative over time.

Here’s how the field of 10 — the five L Funds and the five basic TSP funds — ranked in returns from August 2005 through July 2006:

  • The I Fund, the TSP’s international stock offering, was far and away the best performer, returning 24 percent.
  • Next, came the L 2040 Fund, the most aggressive L Fund, at 9.12 percent.
  • This is followed by the other four L Funds, from the most to least aggressive — L 2030, 8.50 percent; L 2020, 8.15 percent; L 2010, 7.32 percent; and L Income, 5.51 percent.
  • The remaining stock funds were next — the C Fund, 5.42 percent; and the S Fund, 5.35 percent.
  • The volatility-free G Fund, directed into specially issued government securities, produced a 4.84 percent return.
  • The F Fund, the bond fund, brought up the rear with 1.42 percent.

What does this mean to you as a TSP investor trying to plan for the future? First and foremost, it demonstrates the value of portfolio diversification. Notice how nicely the L Funds fall into line in the order we should expect — from most aggressive to least aggressive — with no big surprises. This is what diversification is designed to do — minimize surprise endings.

The L Funds should also be expected to produce more consistent and more predictable returns from year to year. This is an extremely valuable characteristic for those participants nearing or in the withdrawal phase of their lives.

But like placing a random bet on a horse because it carries your favorite number, these return numbers don’t tell us much for future planning purposes. Judging the funds’ character from last year, or any year’s return performance, is risky.

Judging the I Fund to be a superior investment based on its recent performance, for example, incorrectly assumes that this performance will be repeated in the future and ignores the risk that volatility in future returns may produce.

The L Funds have effectively done exactly what they were designed to do — deliver efficient and reliable long-term investment returns through professionally designed and diversified portfolios.

What the numbers can tell us is that it’s best not to gamble on one portfolio product but rather play the field.

Written by Mike Miles
For the Federal Times
Publication August 21, 2006