The Downside of Investing in the TSP's Lifecycle Funds

Many know they should invest more conservatively as they approach retirement, but investing too conservatively can be dangerous if you don’t want to run out of money.

The lifecycle (L) funds in the Thrift Savings Plan are designed to manage investors’ risk as they age. But what’s often a great investment solution for many employees early in their careers becomes less appropriate for many employees as they approach retirement.

This is not meant to be personalized investment advice—every individual will have unique needs and goals that should inform their investment choices—but it is my opinion that these funds are often misused. My goal here is to help readers better understand whether these funds really make sense for their needs. First, it’s important to recognize the value of the L funds.  

The L funds have two main attributes: 

  1. Simplicity. Many times, investing gets overcomplicated. The L funds were created to help simplify TSP investing and allow federal employees to have all their money in a single fund that changes automatically as they approach retirement. 
  1. A better default option. Before the L funds became the default for all new employees, the default was the G fund. Because many people never chose to change their TSP allocation they consequently lost years of potential growth because they were not more aggressive. Now, the L fund closest to an employees expected retirement date is the default fund for new hires. This means that even if new employees don’t change their allocation, they will ything, their TSP will have a much higher chance of growing during the early parts of their career. 

The Downside 

When federal employees are young and have a lot of time before retirement, there are few times that it doesn’t make sense to invest aggressively. But as people approach retirement, the best investment strategy starts to change depending on the situation. Even two people retiring at the same time will probably need to have different investment strategies, depending on personal circumstances. 

Some people have very high retirement savings compared to their retirement needs and others have smaller retirement savings. Some people retire in New York City; others in rural Oklahoma. The best TSP investment strategy will depend on the personal elements of your retirement. The L funds are the TSP’s best shot at a one-size-fits-all solution, so by definition, it is not tailored to your situation. 

The L Funds get more conservative over time and eventually all become the L Income fund (the most conservative L fund). In October 2020, the L Income Fund had the following allocation: G Fund (71.92%); F Fund (5.83%); C Fund (11.60%); S Fund (2.86%); I Fund (7.79%).  

Almost 80% of the fund is made up of the G Fund and the F Fund. Because these two funds are very conservative, the L Income Fund is relatively “safe” but does have slow growth over time. Since 2006, the L Income Fund has grown 4.26% on average per year. With inflation averaging anywhere from 1.5%-3%, the L Income Fund is beating inflation but not by much. In my experience, the L Income Fund is too conservative for most retirees.

Many people know that they should invest more conservatively as they approach retirement but investing too conservatively can be dangerous if you don’t want to run out of money in retirement. With lifespans and retirements lasting longer, many people will rely on their investments to ensure that they can maintain their standard of living while fighting back rising prices caused by inflation.

When people blindly assume that the L funds are perfectly suited for their situation, they may be disappointed. But again, I want to say that the L funds are not always bad. The important thing is that you understand what the L funds are designed to do and if that makes sense for your situation.