Index fund investing has become a commoditized business, and the private sector can perform the service just as well or better than the government.
The normally staid Thrift Savings Plan, the defined contribution plan for six million federal workers and military personnel with over $600 billion in assets, has been the topic of considerable controversy recently. The most recent drama centered around the Federal Retirement Thrift Investment Board’s decision to transition the international (I) Fund to an index that invests in both developed and developing countries—to include China. While controversial from the start, the decision became increasingly mired in political disagreements with Congress and the White House as relations with China worsened. The incident recently ended with the Labor Department’s order that the fund remain invested solely in developed countries and with the White House’s nomination of three new board members to oversee the TSP.
The TSP was established in the mid-1980s as the federal government transitioned to the Federal Employee Retirement System, a hybrid of defined benefit and contribution plans. TSP administrators and staff have done a fine job managing the TSP for the growing number of participants by making gradual improvements over the years. However, index fund investing has essentially become a commoditized business, and there is little reason for the government to continue to render a core service when the private sector can perform the service just as well or better.
The long lead-time required to change the I Fund is the latest example of how encumbered the plan is. The review of the original index of the I Fund took place in 2017, with the initial approval to change the index coming later that year. Projections as of late 2018 noted that the switch would take up to two years to complete. Yet, a variety of similar international index funds had already existed in the private sector for years. One must ask: Why should it take years to transition from one index fund to another in the TSP, when the private sector already offers a range of similar funds?
Private sector services increasingly outshine the TSP in other areas, too. Almost all outside plans offer mobile apps, while the TSP has no plans to do so. The private sector is also increasingly offering additional means for investors to access and secure their accounts, such as with biometrics and “universal second factor” security keys, while the TSP just implemented SMS-based two-factor authentication last year. TSP funds’ rock-bottom fees are now being challenged by index funds in the private sector: Vanguard, Fidelity, and Schwab offer funds similar to the S&P 500-based C Fund but with lower expense ratios, even as TSP net expenses have increased slightly over the last few years. Private sector plans feature increasingly expansive remote educational services, while the TSP provides limited options.
Uniquely in the investment world, TSP participants are also confronted with non-payment of interest to their U.S. government bond fund, or G Fund, each time the debt ceiling is reached. The Treasury Secretary suspends interest payments to the fund as one of several acts to cut back on federal expenditures until an agreement is reached on the debt ceiling. While participants’ G Fund holdings have always been “made whole” following similar suspensions in the past, the spectacle is unsettling for TSP participants. Ultimately, privatizing the funds would take the politics and uncertainty out of TSP investing.
Investment fund activism has become an issue too. By investing your money for you, money managers have control of voting rights conferred by holding those securities, which they can sell or exercise themselves. The head of Blackrock, the sole manager of hundreds of billions of TSP dollars, has been vocal about using voting rights to influence the policies of public companies. A fully privatized TSP would allow participants—not TSP administrators—to choose who manages their funds, taking into account the fund manager’s proxy and other policies.
Moreover, many participants don’t actually “retire” from service. This is particularly true for new Blended Retirement System participants. Established in 2018, all new military service personnel are now defaulted into the TSP. But up to two-thirds of enlistees leave service after one or two enlistments. A privatized TSP system would ease the transition of their holdings to Individual Retirement Accounts to facilitate post-service contributions.
Some federal employees are already participating in a fully privatized investment option via the Federal Employee Health Benefits Plan. As an employer, the federal government does not require its civilian employees to sign up for a one-size-fits-all health plan. Rather, employees choose from a variety of health plans, and some feature Health Savings Accounts that offer a range of funds in which the participants themselves can choose to invest. Periodic HSA investments can be deposited directly from an owner’s paycheck into their investment accounts, and these funds are not managed by government administrators.
A privatized TSP could operate similarly, based on rigorous criteria. One major criterion would be that the net fees would have to fall under an ultra-low ceiling. Another would allow for a broader selection of sector-based funds (such as real estate or precious metals), understanding these involve slightly higher net costs. The G Fund could invest in Treasury Inflation-Protected Securities. There could be requirements for educational resources to ensure they meet standards, and firewalls on how additional services could be marketed to participants.
TSP administrators have talked about setting up a “mutual fund window” to allow for broadened investing. But they have talked about this possibility for years: It was first publicly broached in the early 2010s. Ultimately, why not cut the middleman—and the politics—out of the equation entirely?
A privatized TSP is a win-win for participants and for the private sector. Participants would no longer be subject to the political vagaries in Washington and gain access to enhanced services, and the private sector would be subject to greater competition for the $600 billion in investments of six million investors.
W. Lee Radcliffe is the author of “TSP Investing Strategies, 2nd Edition.” The views expressed in the article are his own.