For Federal employees, the performance of their Thrift Savings Plan (TSP) accounts are important contributors to their financial security in retirement.
A fund’s rate of return includes both how well the fund’s investments perform as well as how much fund participants are charged to operate the fund. Most investors focus on a fund’s investment objective, but they also need to consider the fund’s expenses.
Unless a fund can consistently provide a greater-than-market rate of return over decades, low cost funds will outperform high cost funds especially for long-term investors.
The good news is that expenses for TSP funds remain among the lowest in the investment industry. Lower expenses increase the rate of return for TSP participants.
For the TSP, the effect of administrative expenses (after forfeitures) on earnings for the funds is expressed as the net expense ratio of each fund. The expense ratio for a fund is calculated by taking the total administrative expenses charged to that fund during a specific period and dividing it by that fund’s average balance for that period.
In 2017, the Federal Retirement Thrift Investment Board, which administers the TSP, reported that its average fund gross expense ratio was 0.046% and its average net expense ratio fell to 0.033% in 2017 from 0.038% in 2016. This places TSP expenses in the lowest 5% of the investment industry.
Another way of expressing this cost is that expenses charged to each TSP fund in 2017 were approximately 33 cents per $1,000 of investment compared to 38 cents in 2016. The decline in the 2017 average net expense ratio was primarily due to accruals and increased forfeitures.
TSP expenses (i.e., the cost of administering the program) include the costs of operating and maintaining the TSP’s recordkeeping system, providing participant services, and the printing and mailing of notices, statements, and publications.
Expense ratios in the Investment Industry continue to decline
Falling expense ratios are becoming common throughout the investment industry as exchange traded funds (ETFs) put pressure on investment managers to cut their expenses or lose customers, but TSP expenses remain well below the industry average.
In 2017 average expense ratios for equity mutual funds fell 4 basis points to 0.59%. Average hybrid and bond mutual fund expense ratios declined 3 basis points from their values in 2016, to 0.70% and 0.48%, respectively, according to the Investment Community Institute, which represents regulated funds globally, including mutual funds, exchange-traded funds, closed-end funds, and unit investment trusts (UITs) in the United States. (One basis point equals one hundredth of one percent.)
On average, ICI reports that expense ratios have been declining substantially for more than 20 years. In 1996, equity mutual fund expense ratios averaged 1.04%, and bond mutual fund expense ratios averaged 0.84%.
Comparisons with Popular Funds
Another way of comparing costs is to look at individual TSP funds and measure their costs against popular publicly-traded funds.
For example, the TSP C Fund invests in stocks of large and medium-sized U.S. companies. In 2017, it reported an annual return of 21.82% and had an expense ratio of 0.032%.
The SPDR® S&P 500® ETF Trust (SPY) seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the S&P 500® Index (the “Index”). It reported a return of 21.67% before taxes and an expense ratio of 0.0945%.
The TSP F Fund is invested in a separate account that is managed to track the Bloomberg Barclays U.S. Aggregate Bond Index. This is a broad index representing the U.S. government, mortgage-backed, corporate, and foreign government (issued in the U.S.) sectors of the U.S. bond market. In 2017, it reported an annual return of 3.82% and had an expense ratio of 0.032%.
The iShares Core U.S. Aggregate Bond ETF (AGG) seeks to track the investment results of an index composed of the total U.S. investment-grade bond market and recorded a 2017 return of 3.53% (net asset value). It reported an expense ratio of 0.05%.
The TSP I Fund is invested in a stock index fund that tracks the MSCI EAFE (Europe, Australasia, Far East) Index. Its 2017 rate of return was 25.42% with an expense ratio of 0.032%.
The iShares MSCI EAFE ETF (EFA) seeks to track the investment results of an index composed of large- and mid-capitalization developed market equities, excluding the U.S. and Canada. Its 2017 performance resulted in a 24.94% return with an expense ratio of 0.32%.
Markets go up and down and choosing the right investment option made a substantial difference in an individual’s rate of return last year, but in each case, lower expense ratios helped the TSP funds beat their comparative publicly-traded funds.
Conclusion
Expenses do make a difference. Unless you find a fund that can outperform the market over several decades, long-term investors are better off with a fund that offers lower expenses.
In that respect, the TSP should remain the investment of choice for Federal employees and retirees looking to spread their risk.
