If you’re a Thrift Savings Plan participant, be advised that your liberty and pursuit of happiness are, once again, under attack. The last time this happened, in 2006, it was an attempt by outsiders – the National Association of Real Estate Investment Trusts and their lobbyists – to subrogate your interests to those of their constituents, REIT shareholders fat with paper profits from the now imploding real estate market. Fortunately, TSP’s managers were on your side and fought vigorously, and successfully, to repel the attack.

This time, however, the attack on your plan is coming from the TSP’s administrators themselves. The Federal Retirement Thrift Investment Board is proposing a rule change that will limit the frequency of interfund transfers to two per month in order to curb what the board considers excessive trading by a limited number of participants. Earlier this year, the board sent letters to more than 3,400 investors it identified as frequent traders, asking them to curtail their interfund transfers. Only 549 of investors did not limit their activity, and starting April 1, TSP planned to prohibit them from transferring funds online, although they’ll still be able to make transfers by mail.

In both cases, the threat is more to the integrity of the plan and its management than to participants’ account balances.

In the case of adding a REIT fund to TSP, opponents argued against setting a precedent enabling outside interests to trump those of participants and leaving the plan vulnerable to degradation for the benefit of those outside interests.

In the case of limiting interfund transfers, the problem is TSP management is interfering in a way that threatens the self-direction that is central to the plan’s objectives.

The TSP board’s rationale for its proposal is that the abusive activity of a few active traders is costing the plan, and its participants, too much money. While I agree with this position, the proposed solution is unreasonable. To understand why, we must keep in mind the basic principle on which the plan was founded – specifically, that each participant, and not TSP management, is ultimately responsible for the benefit he or she receives from the plan. As a participant, it’s your responsibility to contribute to the plan and manage its contents.

A few years ago, one of TSP management’s major concerns was that plan participants were too complacent in the management of their accounts – leaving large percentages in only one or two funds, often in the G Fund, over long periods of time. In response to this, the L Funds were created. In addition, during this time, TSP began to value participant accounts daily, and allow daily trading and online access to accounts. TSP management spent time and money to give participants greater account management capability, and now it wants to take away the freedom to use it.

The debate seems to be focused on whether it is acceptable for a participant to trade more frequently than some arbitrary benchmark – two times per month in this case. This misses the point.

I don’t endorse active trading or market timing as a retirement investment strategy. Nor do I endorse buying and holding. But, I do endorse giving you the freedom to manage your account your way.

If participants are going to be held accountable for the management of their accounts, while TSP avoids virtually all liability, then participants must be free to manage their accounts to the limits of the plan’s capabilities.

Each participant’s management strategy, in the end, will either succeed or fail, and it is impossible to predict which. What proves disastrous for one person may be a huge success for another with different needs.

TSP should do what a defined contribution plan administrator is supposed to do – operate the plan in a way that is fair to all participants. The freedom to trade your account the way you see fit, within the capabilities available, is essential.

The proposal to restrict trading will only degrade TSP, making it more like its inferior private-sector counterparts. The problem with TSP is not that there is too much freedom to trade, it’s that the current system of paying for trading costs is unfair. That system is what needs fixing. Each participant should pay the cost generated by his or her strategy. TSP actually encourages frequent trading by having all participants subsidize the cost generated by a few.

I suspect that if the frequent traders had to pay the freight for their activity, the problem would solve itself. Frequent trading would decline and the complaints about subsidy from other participants would cease.

Written by Mike Miles
For the Federal Times
Publication April 21, 2008