Nested Interest

The debate over adding a mutual fund option to the federal retirement investment plan heats up.

Like many Americans, Bruce Krejmas knew something ugly was brewing in the economy in 2007. He decided it was time to put his retirement savings someplace safe.

So Krejmas, who works for the U.S. Geological Survey in Eastern Pennsylvania, shifted most of the money in his Thrift Savings Plan account to the G Fund, a pool of government securities that has long been a pillar of the TSP. While private mutual funds and riskier TSP stock funds plunged at the end of 2008, the G Fund held steady. Krejmas wasn't alone-during 2008, TSP enrollees transferred nearly $20 billion into the G Fund, and its share of total contributions rose by 10 percent.

"I got out about two years ago," he says. "The whole thing was going downhill. I've been sitting on the sidelines." That, Krejmas admits, means he also missed out on the rebound in the TSP's stock funds during the first half of 2009. "The timing was good on getting out. The timing wasn't good on getting back in. I guess I should be thankful," he adds.

A conservative philosophy got Krejmas through the recession, but he wouldn't mind seeing the TSP continue its trend of providing greater freedom for investors to profit during boom times. "I guess it depends on what the fees would be," he says. "I'd like to see something more than an index-aggressive growth."

With the passage in June of a tobacco regulation bill (H.R. 1256) that included several measures affecting federal employees, Krejmas' wish is a step closer to coming true. The House bill included sweeping changes to the Thrift Savings Plan, including a new Roth IRA feature, spousal accounts to ensure that survivors of TSP enrollees can maintain their funds, and an automatic enrollment provision that is expected to swell the ranks of plan participants. But the bill's most controversial reform was a measure allowing-but not requiring-the TSP's governing body to create a means for participants to put part of their investments in mutual funds.

For now, the members of that governing body, the Federal Retirement Thrift Investment Board, aren't in any hurry to act on their authority. Citing concerns from, among others, the Employee Thrift Advisory Council, which represents participants, administrators have said they will not take action on the option just yet.

In the meantime, the debate simmers over whether mutual funds and the TSP are a good match. Not everyone agrees with Krejmas. For many TSP holders, the current formula is a model of simplicity and ease. The philosophy of the plan-low overhead costs; simple options; and passive investments that seek to track, not beat, the market-makes it a relatively simple and safe way for people to put away money for retirement.

"It's a pretty smart investment," says Madalene Ransom, who works for the Agriculture Department in Greensboro, N.C. She remembers hearing a National Public Radio segment not long ago in which commentators noted that the TSP outperformed many private sector funds. "That's partly because the participants get most of the benefits, not the CEO and the administrator," Ransom says. "That meant a lot to me."

Ransom's TSP account took a hit last year, forcing her to put off retirement. But she doesn't regret keeping her money in the plan. Rather, she's grateful her account lost less than the market overall. She's an economist, but admits she's no expert on personal finance. The TSP's simplicity is, to her, one of its biggest selling points.

Surveys have shown plan participants are ambivalent about the idea of a mutual fund option. In a 2006 survey of enrollees conducted by the TSP Board, 46 percent of respondents said they agreed with the statement: "The TSP would be a better program if it offered a wider selection of investment options."

But in a similar survey conducted last year, only 39 percent of respondents said they thought a mutual fund option would make the TSP better. Just 24 percent said they would invest in mutual funds-and the figure dropped to 10 percent when a hypothetical $100 fee was added. Half the respondents said they would have to seek professional advice before taking advantage of such an option.

"I don't get the sense that there's a lot of organic demand for this," says Jim Sauber, chief of staff of the National Association of Letter Carriers and chairman of the Employee Thrift Advisory Council. He says he's received few inquiries from federal employees about the issue. Daniel Adcock, legislative director for the National Active and Retired Federal Employees Association, said the same, as did TSP External Affairs Director Tom Trabucco.

So how did the issue get on Congress' radar screen? The answer is rooted in the history of the TSP.

More Members, More Options

Congress created the TSP in 1986. Its founders-especially former Sen. Ted Stevens, R-Alaska, who is often called the grandfather of the plan-envisioned it as the government equivalent of the private sector's 401(k) retirement plans.

The TSP began with only three funds-the government securities G Fund, the fixed-income index F Fund and the stock index C Fund. As the popularity of the plan has grown, so have its options. In 1996, Congress added two more stock funds, one covering international investments and the other small and medium-sized companies. In 2000, Congress allowed military service members to contribute to the plan, although unlike civilians under the Federal Employees Retirement System, their contributions are not matched by the government. Today, 4.2 million account holders have parked about $224 billion worth of investments in the TSP.

TSP's governing body has taken a conservative approach to managing the program, fending off attempts to use its investing power to promote social, political or foreign policy ends. In the late 1980s, legislators attempted to divest TSP funds from companies doing business with Northern Ireland or South Africa. More recently, there have been attempts to add "terror-free" and "genocide-free" funds, and to prevent investments in companies doing business in Sudan. Another near-miss, from the TSP Board's perspective, was a bipartisan push in 2006 from more than 200 House members to add a real estate investment trust to the plan. Board members were annoyed that Congress tried to add a new investment option without consulting them, and raised concerns about the potential riskiness of the fund.

TSP administrators outmaneuvered REIT proponents in the Senate-but not without some anxiety about the future. "This is an argument we will eventually lose," TSP executive director Gregory Long predicted during a board meeting on April 20.

Unlike the REIT proposal and other previous efforts to modify the TSP, a mutual fund option would not favor or prohibit a specific type of investment. Rather, TSP enrollees could make up their own minds about where to invest. "This is seen as sort of a safety valve," says Adcock. "It would give individuals the ability to invest in those types of options without legislating that a particular industry fund would be one of the funds provided."

Before long, the board began discussing the idea, along with other options for legislative changes to the program. Following the 2008 survey, TSP administrators issued a report recommending a limited mutual fund option. The report noted that 5.3 percent of all 401(k) plans offer such an option, as well as retirement plans provided by some local governments.

Enrollee participation in these plans is very low-according to one estimate, as low as 0.5 percent of all money invested in the plans-but they can be a way to accommodate investors who want more flexibility, without compromising the nature of the plan.

"Our discussions with industry consultants and experts indicate that there is growing agreement on the 'ideal' 401(k) investment structure," the TSP report stated. "Generally, this structure includes a small group of broadly diversified core funds representing the major asset classes, a series of target date funds, and a self-directed brokerage or mutual fund window. This design is seen as the best way to provide sufficient diversification without confusing participants while still meeting the needs of the most investment-savvy participants."

But the report also noted the option could enable "some participants to make very detrimental decisions, such as picking high-cost, highly volatile mutual funds, and thereby damaging their ability to secure a comfortable retirement."

The report ultimately recommended that the board ask Congress to allow a mutual fund option, with participants limited to placing 50 percent-or less-of their investments in such funds But when board members discussed the issue in April, they were deeply divided. Member Gordon Whiting, managing director of investment firm Angelo, Gordon & Co., asked why the fund should stop at mutual funds. Why not allow individual stock purchases and day trading? Long said such features were "not appropriate" for a retirement fund.

Ultimately, the board split 2-2 on the issue of whether to recommend adding a mutual fund option. In June, Congress gave the board the authority to do so on its own at some point in the future. The law requires that administrative fees for the program be paid for by those who use it, and that the board initiates it only if it "determines that such addition would be in the best interests of participants."

The Control Question

For now, the mutual fund option remains a hypothetical. If it were established, it likely would take the form of a money market account, provided by a mutual fund platform provider such as TD Ameritrade or Charles Schwab. TSP enrollees could transfer a certain amount of their balance to the money market account, which then would be distributed to mutual funds of their choosing.

But that leads to a sticky issue-how much control should TSP enrollees have in determining their investments? What responsibility does government, as their employer, have to make sure the money it is contributing to TSP accounts in the form of matching funds is invested wisely? "There's the possibility of people not diversifying enough and not picking broad-based funds that could potentially be much riskier than those available through the [current] Thrift Savings Plan," Adcock says, although he concedes that such concerns could be seen as "paternalistic."

Sauber says the Employee Thrift Advisory Council would not support the idea unless there are limits of 50 percent or stricter on how much of their investments participants could direct to the mutual funds.

But if the proposal did catch on-if, say, there's another boom period in the economy and TSP participants are eager to take a chance on investing in high-flying funds-it could fundamentally change the nature of the plan. "If you drain a lot of money out of the current Thrift Savings Plan, there's the potential of diluting the current economies of scale that enable the program to have relatively low administrative costs," Adcock says.

The result could be a dramatically different TSP. "This would totally, radically alter a plan that has been in place since 1986," TSP Board Member Alejandro Sanchez said during the April meeting.

One issue would involve providing financial advice to the thousands of TSP holders who say they would need help with a mutual fund option. In their recommendations to the TSP Board, the plan's administrators said outreach efforts would be minimal-at most, some additional information and brochures added to education efforts for the Roth feature and other recent changes. Employee groups also are hesitant to offer specific financial advice. "We try to advise people on the TSP in general, but we don't specifically provide investment advice in which ones are going to perform better than others," Adcock says.

The issue is not academic-especially after thousands of TSP holders saw their savings erode during the past year. In 2008, the C Fund lost 36.99 percent of its value, while the S Fund dropped 38.82 percent. Both funds have rebounded in 2009-as of early September, their losses stood at 7.04 percent and 9.61 percent, respectively, for the past year. In many cases, TSP investors' losses were smaller than their private sector counterparts with 401(k) plans experienced. Still, many were left wondering what they would have done with more choices.

"When the stock market is falling for a prolonged period of time, TSP participants do not have many options for making money," says Tom Crowley, who runs TSP Talk, an online forum for plan participants. "Sure, bonds may go up some in value, and the G Fund will pay a minimal amount, but being able to invest in gold, oil or other commodities, as well as real estate funds, or even a bearish fund that rises in value when stocks drop, will help aggressive investors by giving them an opportunity to invest in appreciating funds while most stocks are dropping. It would involve more risk, but if used in conjunction with a diversified account, it could actually be more safe."