I don’t like the L Funds. More specifically, I don’t like the L 2010, L 2020, L 2030 and L 2040 funds. But it’s important to understand the good reason that I don’t like them, as opposed to the bad reason some investors are lately questioning them.
The Thrift Savings Plan’s L Funds – or lifecycle funds – vary their mixes of TSP’s five stock, bond and government securities funds based on when participants expect to begin making withdrawals. Those who are questioning their value are typically inspired by the fact that all five L Funds lost value during 2008 and, so far, in 2009.
Investors hate losses – any losses. So, what’s the problem? You can invest your account in the G Fund, the TSP government securities fund, and avoid the prospect of losing your principal to the vagaries of the markets. The G Fund is the safest harbor from market volatility available anywhere. The L Funds don’t guarantee, and never have guaranteed, against a loss of principal the way the G Fund does. In fact, I think TSP officials have done a pretty good job of making it clear that all of the L Funds possess a risk of loss.
So, why invest in anything other than the G Fund? There is only one good reason, and that would be because you need a higher expected rate of return than the G Fund offers to give yourself a chance of achieving your long-term financial goals. If you’re invested in anything other than the G Fund, it should be because investing only in the G Fund will likely ensure that you will fail to achieve your long-term financial goals. It doesn’t make sense to invest in a way that protects you against today’s market volatility if it also guarantees that you’ll run out of needed retirement income while you’re still alive.
There is no investment return without risk. If you want the opportunity for more return, you need to accept greater risk.
Your job as your own pension fund manager is to determine how much return you’ll need to support your pension fund’s expected benefits, and then to obtain that return with a minimum of risk. The L Funds’ asset allocation models are designed to help you do this – minimize the risk you take to achieve a certain expected rate of return. Since all of the L Funds produce expected rates of return that are greater than the G Fund’s, they all bear greater risk of loss than the G Fund. The fact that they lose money from time to time isn’t a sign of failure, it’s inevitable, and it doesn’t indicate that the rates of return they’ll produce in the future have diminished. In fact, as their values have fallen, the likelihood has only increased that they’ll produce their expected rates of return going forward.
All of this is meant to make it clear that a losing year is not a reason to criticize the L Funds. Criticizing any of the TSP’s funds for losing money is an amateur’s mistake. The L Funds have done exactly what you should have expected – produced returns that fall between those of the best and worst performing TSP funds during any measurement period.
The reason to avoid the L Funds is more subtle. All of the L Funds except the L Income Fund mechanically adjust their asset allocation over time. The L Income Fund, which is intended for investors who already are withdrawing from their TSP accounts, is an exception to the rule and a useful choice for those with low expected return requirements. The allocation adjustment in the other L Funds is a problem since this adjustment is not likely to improve your pension fund’s ability to support your goals, and may actually hurt its performance.
Think about this: As their values have fallen over the past year, the L 2010, L 2020, L 2030 and L 2040 funds have continually shifted to more conservative allocations. Yet, as your account’s value has fallen, your need for higher rates of return in the future has grown, if you’d like to make your existing retirement plan work out as anticipated. While shifting your allocation out of stocks before the crash might have been a smart thing to do, shifting to a more conservative allocation after the crash may be compounding, rather than solving any problems that were caused by the decline.
Every investment decision you make should be taken solely for the purpose of furthering your interests, for its ability to increase the odds of achieving your goals. The reason to avoid the L Funds isn’t because of what they’ve done recently, it’s because they force arbitrary investment decisions into your retirement plan, and that can do more damage in the long run than an occasional bear market.
Written by Mike Miles
For the Federal Times
Publication March 9, 2009