The Army Lawyer | Issue 5 2021View PDF
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Every new Army recruit is also an investor. In fact, they invest in government securities, bonds, international corporations, and virtually every company in the entire U.S. stock market. Now that the blended retirement system (BRS) is the retirement plan for all new recruits and many mid-career Service members, Soldiers are automatically enrolled and have money invested monthly into the Thrift Savings Plan (TSP). Whether Soldiers like this reality or not, selecting from fund options is essential for Soldiers to understand and critical for leaders to appreciate. Why? The difference between investment allocation choices can significantly impact overall financial well-being, a comfortable retirement, and even the financial future of Soldiers’ beneficiaries. Indeed, “investment allocation is one of the most important factors affecting the growth of your account.”2 This article aims to familiarize readers with the basics of asset allocation within the TSP, address some of the assumptions that underlie the funds, and give TSP investors ideas to tailor their asset allocation to their specific risk tolerance and personal situation.

What Is Asset Allocation?

Asset allocation, in basic terms, describes the ratio of different types of stocks and bonds in one’s portfolio. Stocks are shares of ownership in a specific company, such as Microsoft, Apple, or Wal-Mart, the value of which fluctuate as the companies perform—for better or worse—over time. Bonds, on the other hand, are more of a loan to an entity or company from the investor (imagine a bank or investor loaning money to the company at a specific interest rate). Because of these differences, stocks are more volatile than bonds. While stocks have historically provided investors greater returns than bonds, they are also much more susceptible than bonds to sharp downward turns. Conversely, bonds provide greater stability and less volatility, although their long term prospects for growth pale in comparison to historical stock returns. In a portfolio with a combination of stocks and bonds, bonds offer a layer of stability, dulling the sometimes sharp fluctuations in market value that stocks produce.

Generally, young investors have more time to wait out volatile markets, meaning they should weight their retirement portfolio heavily in stocks. A long “investment horizon” (i.e., more time to wait until you need the money)—coupled with the long-term past performance of stocks—can lead to a winning combination for retirement. Conversely, as retirement age approaches, preserving the accumulated wealth in one’s account becomes more important, especially since watching the value of one’s account fall in volatile markets could be detrimental to retirement plans—and one’s sanity. Therefore, the percentage of bonds in an overall portfolio should typically increase with age. Then, when it is close in time to when the money will be needed, the bonds will smooth (although not necessarily stop) dramatic account value fluctuations.

Everything Starts with Risk

Risk, in general terms, is exposure to a danger, such as financial loss. Risk is often discussed in comparison to return, which is the possibility of financial gain. The volatility of a particular investment generally indicates its level of risk. For example, a company’s stock price fluctuates up and down daily, based on good or bad earnings, profit, new products, new competition, or for a variety of other reasons.3 The intensity of swings in a stock’s price over time determines its volatility. High-volatility investments usually indicate high potential for both significant financial gain and significant financial loss. In other words, investors who take bigger risks can sometimes see even bigger returns in exchange for assuming that risk. In broadest terms, the overall goal of investing is to mitigate risk while maximizing returns.

Another element of risk to consider besides market fluctuation is the risk of not having enough money for retirement. This risk can arise from multiple sources. First, a portfolio too heavily weighted in stocks too close to retirement could mean that a sharp market downturn forces the investor to continue working or accept a lower standard of living in retirement. Second, a portfolio too heavily weighted in cash and bonds in one’s early investment years could mean the investments fail to grow to a retirement-worthy sum or, worse, fail to beat inflation, which constantly diminishes the purchasing power of one’s savings.4 Third, there is a risk that, despite prudent investment decisions, an individual simply does not invest enough money throughout one’s working years.5 Therefore, every investor must determine how much risk they can tolerate at each stage of their life, also known as their “risk profile.” Relevant factors influencing one’s risk profile include age, quality of life expectations, retirement goals, and individual preferences and behaviors.

What Options Exist Within the TSP?

There are five core funds in the TSP (namely G, F, S, C, and I) as well as 10 Lifecycle funds (L-funds) which own different proportions of the five core funds. Of the five core funds, the G Fund and F Fund are similar to bond funds, although the G Fund will never lose money.6 The C Fund and the S Fund are composed of stocks of virtually every company traded on U.S. markets, with C Fund holding stocks of roughly 500 of the biggest companies and S fund holding stocks of the remaining smaller, publicly-traded companies. The I Fund holds stocks of major non-U.S. companies from over twenty different developed countries.7

The newest additions to the TSP funds are the L-Funds. L-funds are “professionally determined investment mixes” of the five core funds, and those mixes automatically become less risky as the fund nears its target date.8 For example, the L-2065 fund is the most aggressive L-fund and assumes participants will want to withdraw money (i.e., retire) on or around 2063 or later, so it holds a very high percentage of stocks now—currently around 99 percent. Every three months, fund administrators incrementally lower the risk profile of the fund by exchanging stock and bond funds for a higher proportion of the risk-appropriate G fund. By the year 2050, for example, the percentage of stocks in the L-2065 fund will have decreased from 99 percent to 78 percent, whereas the G fund will account for over 16 percent of the fund. L-funds are a fire-and-forget missile of the investment world, allowing investors to continually invest in the same, single fund their entire career and never worry about having to make adjustments for risk as they near retirement.

Literally 100 percent of newly-accessed Soldiers will have monthly contributions flowing into their TSP account after 60 days of service. Until September 2015, the default fund was the safe, and therefore relatively low-performing, G-fund.9 Today, if a Soldier does not log on to TSP.gov and dictate how money should be invested, the funds will automatically be invested in the appropriate L-fund for the Service member’s age.10 And thankfully so. The younger demographics of the military should embrace the risk-reward qualities of the L-funds, especially compared to the slow-growing G fund. After all, market volatility will always exist; younger investors with a long investment horizon should view temporary downward trends as an opportunity to buy stocks and stock funds at discounted prices.

Roth v. Traditional: A Not-So-Taxing Choice

As TSP investors, Soldiers must now choose when they want to pay taxes on their TSP contributions. There are three choices: Roth, traditional, or a mix of both. If making Roth contributions, Soldiers pay income tax on the contributions before the money is invested, but they can withdraw the money, tax-free, in retirement.11 If making traditional contributions, the Soldier does not pay income tax on the money before it is invested; but, they must pay taxes when they withdraw money at their then-existing income tax rate. Any Government contributions, such as the 1 percent automatic and any matching contributions, are characterized as traditional, regardless of the Soldier’s choice between Roth and traditional contributions.

What choice is best? While individual circumstances may differ, Roth is generally a prudent choice for most Soldiers.12 Paying tax now on TSP contributions and withdrawing the money tax free can be a lucrative strategy because certain tax-exempt service payments, such as housing and subsistence allowances, artificially lower the overall tax rates Soldiers pay on their current earnings. Additionally, because tax rates can change year-to-year, paying taxes now can serve as a hedge against the possibility of rising tax rates in the future. For more information, the TSP website has a comparison calculator, although users may find it of limited efficacy since the inputs require significant assumptions about current and future tax rates.13 At the end of the day, the choice to invest is most important, so the choice of tax treatment should not stifle one’s desire to save for retirement. After having established a baseline understanding of investing generally, it is important to tackle some assumptions or common misperceptions about investing in the TSP.

First Assumption: The L-Fund Is Best for Me

While the L-Fund is a great default option for TSP participants, an individual’s risk tolerance, personal financial situation, and other investments might change that assumption. Specifically, the percentage of cash and bond holdings (G and F funds) in the L-funds might over- or under-shoot an individual’s risk tolerance. If an investor cannot stand the idea of a shrinking portfolio balance or even feels compelled to check the portfolio balance constantly, they might find the age-appropriate L-fund is too aggressive and decide to own a higher proportion of safer investments, such as the G and F fund.14

Conversely, some investors might think the L-funds are too conservative, especially if one considers life expectancy and military pensions. Military retirees are generally expected to live at least as long as the general U.S. population.15 Additional factors, such as one’s current health, income, and gender, may cause a retiree’s life expectancy to increase by a significant amount.16 Increases in life expectancy increase one’s investment time horizon, suggesting that holding a higher percentage of stocks vis-à-vis bonds for longer periods of time might be beneficial. Yet, the L-funds do the opposite, sharply increasing the percentage of bonds as the target date approaches to a final composition of less than 30 percent stock funds when the target date is met.17 Given that the conventional wisdom is to hold 60 percent stock funds at the start of retirement,18 this would be an extremely conservative stock-to-bond ratio that runs the risk of inflation outpacing portfolio performance, further exacerbated by increases in life expectancy. Likewise, these risks become even more pronounced when one factors in the prospect of a military pension, either under the legacy system or BRS. A military pension is an inflation-adjusting annuity that is backed by the U.S. Government, meaning it should be viewed similarly to a large cash or G fund holding. If a Soldier is entitled to a military pension, the cash-and-bond qualities of that pension skew their overall portfolio conservatively, meaning they should be comfortable with higher stock percentages in their TSP investments.

Second Assumption: I Don’t Have the Time or Training to Pick Funds on My Own

Investing in the TSP is simple and accessible for everyone. The limited number of fund options tend to make choices easier. If an individual has a low risk tolerance, short investment horizon, or wants to preserve their account balance at the expense of long-term growth, they should own a higher percentage of cash and bonds (G and F funds). If an individual has a high risk tolerance, a long investment horizon, or a vested military pension, they ought to consider owning a higher percentage of stocks (C, S, and I funds). However, investors should know that only the lifecycle funds rebalance automatically as the investor ages. If the five core funds are owned outright, the individual is responsible for rebalancing the stock-to-bond ratio to keep a desired mix of investments and adjust for changes in risk tolerance.

Third Assumption: I Don’t Need to Invest in the TSP

While investing in the TSP is not a requirement per se, every new Soldier is automatically invested through agency automatic contributions, so they should have a baseline of knowledge about how it works. Moreover, investing in the TSP is a great idea for everyone due to the miracle of compound interest, the opportunity cost of not investing, the uncertainty of a military or civilian pension, and agency matching contributions. First, retirement accounts (like the TSP) represent an enormous benefit for individuals to save and grow their wealth. Compound interest is the monetary phenomenon by which the interest earned on one’s principal begins to generate its own interest.19 Over time, compound interest amplifies gains and causes account values to grow—exponentially. Second, and conversely, the Internal Revenue Service (IRS) sets yearly limits on investments in tax-advantaged accounts like the TSP, and one can never travel back in time, literally or figuratively, to contribute to a prior year’s TSP limit that was left unfulfilled. Third, investing in the TSP is a smart idea because military pensions are not guaranteed. Indeed, only about 19 percent of individuals who begin military service will retire from the military,20 and most civilian companies are moving away from pensions in favor of 401(k)-style retirement plans.21 For those who are not vested in a military pension, investing in the TSP is a simple and effective way to hedge against the prospect of changing jobs, medical disability, non-selection for promotion, or post-military civilian employers that do not offer a pension. Fourth, Service members now have an option to instantly boost their pay—that is, if they invest at least 5 percent of their base pay into the TSP, they receive an automatic 4 percent pay raise in the form of agency matching contributions! As an added benefit, the TSP funds are extremely low cost and diverse, representing stocks and bonds of thousands of companies from around the world.22 There is no need to ever transfer funds out of the TSP only to invest them with an investment advisor who might promise flexible or fanciful strategies at a significantly higher cost.

Fourth Assumption: I Must Choose Between an Individual Retirement Account (IRA) and the TSP Because I Cannot Invest in Both

Wrong! An IRA is a separate and distinct form of tax-advantaged account that individuals can use to save and invest for retirement. IRAs have many characteristics of the TSP, including traditional or Roth tax options; although, Roth accounts are limited to those investors with an adjusted gross income below certain thresholds.23 An IRA can be established with virtually any civilian brokerage company (such as Charles Schwab or Vanguard) and the fund options are virtually unlimited, depending on the brokerage company selected. Based on IRS limits which change periodically, individuals can contribute up to $6,000 in an IRA and up to $20,500 in the TSP in 2022.

Fifth Assumption: Once I Invest in the TSP, I’m Stuck with Those Options for the Rest of My Life or, Conversely, Once I Separate or Retire from the Military, I Must Move My Money out of the TSP

Soldiers are generally free to keep their money invested in the TSP or transfer it as they see fit. First, individual contributions always belong to the Soldier and any matching contributions are vested after completing two years of military service.24 In many cases, Soldiers are eligible to transfer money from other 401(k)s into the TSP, which is a great option considering the rock-bottom costs of TSP funds. Second, if considering a transfer out of the TSP, individuals should think twice. Very little evidence, if any, exists which proves financial managers can outperform broad market indexes (like the C, S, I, or F funds) over long periods of time.25 While personal financial managers may tout more fund options than the TSP, they typically receive a fee for managing your account. Unsurprisingly, the funds they would select are almost assuredly more expensive and, in some cases, outrageously expensive when compared to the TSP. Does a .04 percent fee matter compared to a .25 percent or even 1.5 percent fee? Absolutely. These seemingly small numbers might ruin your financial future by robbing you of over 40 percent of your earnings during your lifetime of investing.26 Fees matter, and the TSP is among the lowest fee providers in the marketplace.

Conclusion

Military life can be challenging, disruptive, uncomfortable, and stressful at times. Financial considerations are often a root cause or an amplifier of the stressors associated with military life. Fortunately, the TSP is a tool that leaders and Soldiers can—and should—utilize to mitigate these financial stressors. Since every new Army recruit is an investor, they should know some of the basics surrounding TSP funds, risks, tax characterization of contributions, and asset allocation. Whether in a legal assistance capacity, command advisory capacity, or the proverbial water-cooler talk around the office, judge advocates should share their knowledge of the TSP with Soldiers and leaders. As the common Wall Street adage goes: a rising tide lifts all ships.27 TAL


MAJ Loscheider is the Group Judge Advocate for 10th Special Forces Group at Fort Carson, Colorado.

MAJ Cohen is a student at Georgetown University Law Center, in Washington, D.C., pursuing a Masters in Law degree.


Notes

1. The authors of this article are not investment advisors, and their opinions should not be considered investment advice. This article is solely for informational and educational purposes. For additional information on the blended retirement system, see Major Courtney M. Cohen, The Blended Retirement System: What Leaders Need to Know, Army Law., no. 4, 2019, at 23.

2. See Summary of the Thrift Savings Plan 12 (2021), https://www.tsp.gov/publications/tspbk08.pdf (emphasis added) [hereinafter TSP Summary].

3. Lately, the markets have shown this to be true. For example, COVID-19 had a dramatic impact on world markets, especially from February 2020 through June 2020, frequently causing daily fluctuations of five percent or more across broad market indexes. See, e.g., Matt Phillips & Jeanna Smialek, Markets Plunge as a Global Recession Appears Almost Inevitable, N.Y. Times (Mar. 16, 2020), https://www.nytimes.com/2020/03/16/business/stock-market-coronavirus-federal-reserve.html.

4. Inflation causes prices to rise marginally over time, typically 2 to 3 percent per year, and can have a major impact on portfolios over time. For example, $10 in 1920 would require $129.24 in 2020 to maintain the identical purchasing power of that amount. See, e.g., Inflation Calculator, US Inflation Calculator, https://www.usinflationcalculator.com/ (last visited Sept. 30 2021).

5. While each individual’s circumstances may differ, some financial advisors recommend individuals invest 15 percent (or more) of their pay during their working years. See generally How Much Should I Save for Retirement?, Fidelity (July 29, 2021), https://www.fidelity.com/viewpoints/retirement/how-much-money-should-I-save.

6. As with the risk discussion earlier, one should be rewarded for taking risks. Therefore, the F fund should be expected to outperform the G fund over long periods of time. See, e.g., Lyn Alden, Why the F Fund Has Been the Worst Performing TSP Fund Lately, FedSmith (Oct. 10 2018, 3:17 PM), https://www.fedsmith.com/2018/10/10/f-fund-worst-performing-tsp-fund-lately/ (asserting that, despite recent lackluster F Fund performance, “historically, the F Fund has given investors better returns over the long run than the G Fund in exchange for a little more risk”).

7. Note that there may be a benchmark shift to the I fund in the near future, to include the addition of smaller international companies as well as companies from emerging markets. See Ian Smith, FRTIB Moving Forward With I Fund Change, FedSmith (Nov. 14, 2019, 8:19 AM), https://www.fedsmith.com/2019/11/14/frtib-moving-forward-i-fund-change/.

8. See Lifecycle (L) Funds, Thrift Savings Plan, https://www.tsp.gov/funds-lifecycle/ (last visited Oct. 18, 2021).

9. See TSP Summary, supra note 2.

10. Id.

11. If it’s a “qualified withdrawal,” meaning five years have passed since 1 January of the calendar year in which you made your first Roth contribution and you have reached age 59 ½, have a permanent disability, or have died. Traditional and Roth Contributions, Thrift Savings Plan, https://www.tsp.gov/making-contributions/traditional-and-roth-contributions/ (last visited Oct. 18, 2021).

12. High-earning spouses, senior military members, or a large variety of personal circumstances may upend this assumption. See an investment advisor and/or tax professional for specific advice.

13. See Contribution Comparison Calculator, Thrift Savings Plan, https://www.tsp.gov/PlanningTools/Calculators/contributionComparison.html (last visited Sept. 30, 2021). Additionally, for a discussion with comparisons, see TSP Summary, supra note 2, starting at page 8.

14. See, e.g., Carolyn Marsh, Two Asset Allocation Rules You Need to Follow at Any Age, Forbes (Apr. 23, 2015, 2:39 PM), https://www.forbes.com/sites/greatspeculations/2015/04/23/two-rules-of-asset-allocation-to-follow-at-any-age/#781740695ea8 (suggesting that younger investors are investing less in stocks in stark contrast to target date fund providers, which are moving toward more aggressive stock-bond allocations in their funds).

15. See Off. of Actuary, Dep’t of Def., Statistical Report on the Military Retirement System, Fiscal Year 2017, at 279-80 (2018), https://actuary.defense.gov/Portals/15/Documents/MRS_StatRpt_2017%20v4.pdf?ver=EyLi_moEtY6jlgX9GeLMxw%3D%3D. See also Actuarial Life Table, Soc. Sec. Admin., https://www.ssa.gov/oact/STATS/table4c6.html (last visited Oct. 18, 2021).

16. See sources cited supra note 15.

17. See, e.g., L 2040, Composition Tab, Thrift Savings Plan, https://www.tsp.gov/funds-lifecycle/l-2040/?tab=composition (last visited Oct. 18, 2021).

18. Rebecca Lake, The 60/40 Portfolio Is Dead for Retirement Planning, US News & World (Apr. 23, 2019), https://money.usnews.com/investing/investing-101/articles/why-the-60-40-portfolio-is-dead-for-retirement-planning (suggesting that the “classic approach” of 60% stocks in retirement runs a risk of not having enough growth potential in light of increasing life expectancies).

19. Jason Fernando Compound Interest, Investopedia, https://www.investopedia.com/terms/c/compoundinterest.asp (Feb. 16, 2021).

20. U.S. Dep’t of Def., The Uniformed Services Blended Retirement System 1 (2018), https://militarypay.defense.gov/Portals/3/Documents/BlendedRetirementDocuments/BRS%20Frequently%20Asked%20Questions%2003282018.pdf?ver=2018-03-28-235150-797v.

21. Jennifer A. Kingson, Companies Are Racing to Dump Their Pension Plans, Axios (Aug. 7, 2019), https://www.axios.com/companies-are-racing-to-dump-their-pension-plans-679828fc-65df-401f-956d-8b57eb1f5438.html (“Among Fortune 500 companies, only 81 sponsored a pension plan in 2017, down from 288 in 1998 . . . .”).

22. Costs for the administration of the TSP are subsidized by forfeited agency contributions and earnings as well as loans against accounts. See Administrative and Investment Expenses, Thrift Savings Plan, https://www.tsp.gov/tsp-basics/administrative-and-investment-expenses/ (last visited Oct. 18, 2021).

23. For 2021, the adjusted gross income for married filing jointly must be less than $198,000 to contribute this amount. See Amount of Roth IRA Contributions That You Can Make for 2021, IRS, https://www.irs.gov/retirement-plans/amount-of-roth-ira-contributions-that-you-can-make-for-2021 (last updated June 26, 2021).

24. Your account balance must also be greater than $200, otherwise TSP will send a check to your last address for the amount once you separate from service. Leaving the Federal Government, Thrift Savings Plan, https://www.tsp.gov/changes-in-your-career/leaving-the-federal-government/ (last visited Oct. 18, 2021).

25. See, e.g., Mark Hulbert, This Is How Many Fund Managers Actually Beat Index Funds, MarketWatch (May 13, 2017, 10:46 AM), https://www.marketwatch.com/story/why-way-fewer-actively-managed-funds-beat-the-sp-than-we-thought-2017-04-24.

26. See Sec. & Exch. Comm., How Fees and Expenses Affect Your Investment Portfolio (n.d.), https://www.sec.gov/investor/alerts/ib_fees_expenses.pdf.

27. See generally Ken Alessi, A Rising Tide Raises All Ships, Linkedin (July 15, 2019), https://www.linkedin.com/pulse/rising-tide-raises-all-ships-ken-alessi.

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