Federal employees operate in a political environment. It is easy to lose sight of this when going into work every day and working on projects or subjects that seem far removed from politics.
Even the most politically averse federal employees probably realize the political environment that is an inherent part of the job when, each year, Congress and the administration in power wrangle over the annual federal pay increase for months on end. Politics also comes into play in deciding your agency’s budget and whether specific projects get funds to continue operating for another year.
But here is another angle. Most federal employees participate in the Thrift Savings Plan (TSP). Especially for those employees under the FERS system, the TSP is critical to your retirement future. The TSP makes it easy to invest in the basic funds or in lifecycle funds that allocate your investments throughout the basic funds depending on your retirement horizon.
The TSP funds are essentially index funds. There is not a fund manager deciding whether your investment money should go into financial stocks or whether to invest millions of dollars on the fortunes of a specific company. An index fund spreads the risk over hundreds of companies that fall into the broad fund category.
The theory behind an index fund isn’t new. It was first introduced by John Bogle of the Vanguard Group In 1975. His idea was to create a very low-cost mutual fund that would not try to beat the returns of the stock market as measured by Standard & Poor’s 500 index. An index fund reflects the index by buying each of the index’s 500 stocks in amounts equal to the weightings within the index itself.
The TSP C fund uses the S&P 500 index in much the same way as the original concept for the Vanguard index funds although the fees and expenses for TSP shareholders are much lower than any other index fund. In effect, TSP investors have the advantage of very low fees and relatively low risk investing through the use of index funds. As all investors who pay any attention know, there is risk in buying stock as the funds go up and down based on broad economic trends that affect stock prices.
Your TSP funds are invested in a way that is generally immune from the political pressure cooker inhabited by our elected representatives. But that does not mean that the TSP funds will remain immune from politics in the future.
The TSP funds are now investing many billions of dollars. That is a huge pot of money that lobbyists, industry groups, financial advisors, etc. would love to share. And, with the large amount of money flowing into the campaign coffers of our elected representatives, some of these Congressmen are going to try and serve the interests of their donors by occasionally advocating changes to the TSP.
That is not to say there should not be changes to the TSP. The TSP management has been diligent in representing the broad interests of investors and to resisting political pressure to add new funds that may not always be in the best interests of investors.
Here is a new twist though. Congressman Danny Davis (D-IL) is concerned about the role of women and minorities and your TSP money. According to a report in Government Executive, the Congressman is bothered that the indexing approach used by the TSP may exclude financial firms run by women and minorities from getting a bigger piece of the billions of dollars in the TSP pool and wants to consider using actively managed funds instead of index funds. The concerned Congressman stated: “The executive director of the Federal Retirement Thrift Investment Board revealed that there are minority firms with talent in long-term financial management. However, most of those firms gravitate toward the active fund management business, which is not an investment strategy of the TSP. Research by the TSP indicates that there may be only one minority-owned firm that deals with passive management of index funds.”
DC Delegate Eleanor Holmes Norton is also jumping on this bandwagon as it gets ready to roll. The elected representatives are professing concern for the overall return of TSP investors, of course, but this is national politics at its best. Achieving a goal of putting more money into the pockets of financial investment firms may best be accomplished with a diversionary tactic–in this case, using the front of enhancing the the role of women and minorities to introduce the concept of paying private investment companies to start actively managing TSP funds.
In reality, there have already been plenty of studies comparing the returns of actively managed funds to the returns provided by index funds.
In a nutshell, there is a recent quote from a Wall Street Journal: “If this is supposed to be a stock picker’s market, the stock pickers need to start picking better stocks. Bearish periods are touted as stock picker’s markets because money managers are supposed to deftly hand-select winning companies rather than rack up losses along with broad benchmarks that are tracked by popular index funds. Money managers, who charge far higher fees than index funds, have happily promoted this idea.“
Here are the most recent results of what investors who are paying much higher fees have gotten for their money. in 2008, they have fallen behind the indexes in six of nine major categories of U.S. stock funds. In the three areas where they are ahead, it is by a half-percentage point or less.
The stock pickers’ record during the six bear markets from 1973 to 2007 is three for six, according to research by Vanguard (the Vanguard Group also runs a number of actively managed funds). Beating the market half the time does not make much of a case for having an actively managed stock fund as the higher fees will cost investors more money.
And it isn’t just the Wall Street Journal with this view. As noted by a columnist from Money magazine: “Index funds’ consistency makes them ideal building blocks for creating a diversified portfolio that contains all sizes of stocks, styles of investing and different types of bonds as well. As if that’s not enough, index funds tend to be tax-efficient, which is a fancy way of saying they generally give up less of their gains to taxes.”
Or consider a similar quote from Bankrate.com: “Actively managed funds are an entirely different story. With these, a mutual fund manager or team of managers buys and sells a variety of holdings in an attempt to beat their respective index. Therefore, portfolio turnover is generally higher, the funds are less tax-efficient and they require more hands-on management. In the end, all that activity often doesn’t guarantee top returns.”
Many investors also read columns by Scott Burns on a regular basis. Here is his observation on the topic of actively managed funds vs. indexed funds: “I’ve heard brokers say that ‘expenses don’t matter if the return is there’ for more than 40 years. It’s absolutely true, except for one problem. Expenses are constant. Performance is uncertain. Invariably, today’s top manager outruns his selection luck and performance deteriorates. Long-term, odds are that managed fund performance will be well below the performance of an index fund.”
For the most cynical observers of our political process, there is a certain irony in this quote from a financial advisor who wants to start getting a piece of the investment fees from the TSP: “[C]oncerns about political manipulation were overblown and might prevent fiduciaries from considering viable investment offerings. ‘I hear this concern about political manipulation, but I’m not sure what that manipulation might be….’ ” (For those wanting more information, check out Constructing Your TSP Options: Follow the Money)
Perhaps it is just too obvious. To many observers with money at stake in the TSP, the political manipulation that the financial advisor cannot see includes changing the TSP’s investment strategy from relying on index funds to actively managed funds–with higher fees going to the fortunate fund managers selected to receive the funds and choose the stocks for TSP investors. Of course, this would not be done for any financial advantages for our elected representatives–it would be for the more noble cause of standing up for the rights and financial advantages of women and minorities.
The scenario that is playing out in Congress is actually humorous as the real motivation of those with the noble comments seem so apparent. The humor may not be so obvious though if you happen to have much of your retirement future riding on the outcome of the political process.
TSP investors may want to point out to the Congressional representatives crying out for more research into this issue that the research has already been done and the results are pretty conclusive for those who choose to take a look at them.