October 22, 2012
TSP administrators should beware: private-sector funds are becoming price-competitive with the TSP as their expense ratios fall to within reach of those of funds in the Thrift Savings Plan.
The TSP historically has had several features to recommend it compared to investing in other accounts. Foremost are the tax-advantaged nature of the TSP funds and the extremely low expense ratios compared to funds offered by outside companies.
However, the selection of funds in the TSP is limited compared to the range of investment products offered by major fund companies.
As TSP administrators look to expand services for TSP participants over the next five years, however, expenses might begin to rise. According to estimates, TSP budgets will increase by double-digit percentage rates from $143 million in FY2012 to an estimated $224 million in FY2014 and to an estimated $253 million in FY2017. More services and options – and more TSP employees to provide those services – require higher budgets. And expanding budgets could mean higher expenses for participants investing in each of the TSP funds.
The cost advantages are disappearing, with major investment companies lowering expense ratios to incredibly low levels over the past year. In the most recent announcement, BlackRock – the same company that currently manages many of the funds in the TSP – will initiate a series of ultra-low expense index funds this week.
As background, fund companies can charge a variety of fees for investing in their funds. The primary means is the “expense ratio,” or a small percentage of the amount invested in the fund to cover a variety of management and other expenses. All investment companies have an “expense ratio” for their funds, as do the funds in the Thrift Savings Plan.
According to the Investment Company Institute, the average expense ratio for stock mutual funds in 2011 was 0.79%, or $79 for every $10,000 invested in the fund. The average expense ratio for bond mutual funds was 0.62%, or $62 for every $10,000 invested. In comparison, the expense ratio for TSP funds was 0.025% in 2011, or $2.50 per $10,000 invested. That’s a difference of $76.50 or $59.50 respectively –money that can be directly invested into our accounts each year for greater growth over the long term. (Depending on TSP participation in the coming years and growth of funds, expenses could increase to 0.066% in FY2014 in one estimate, however.)
Separate from the expense ratio, some mutual funds have additional fees such as account maintenance fees, fees to open and close the accounts, fees for each transaction, and what are called “12b-1” fees, or fees that can be levied to advertise and market a company’s funds. These fees are all contained in any given fund’s prospectus.
And then there are “load funds,” funds that actually take a percentage of the total amount of money that you are investing when you invest it (or a “front-end load”) or a fee of the total amount in your account when you sell it (called a “back-end load”). So if a fund has a 5% front-end load fee (and these types of funds still exist, believe it or not), and you invest $10,000, the fund company keeps $500 right off the bat and you are actually only investing $9,500. Much of this “load” goes to the salesperson who sells the fund to you.*
It goes without saying that the TSP features only “no-load funds,” as are many mainstream funds. The TSP has historically featured the lowest expense ratios for investing in basic index funds over the past 25 years, but this is now changing.
BlackRock this week is introducing what it calls “core funds,” which are index funds that feature extremely low expense ratios. Its “IVV,” or large company stock index fund similar to the C Fund, has a total expense ratio of .07%. Its “IEFA,” or international fund similar to the I Fund, has a total expense ratio of 0.14% (international funds are usually slightly more expensive than US funds due to trading on multiple stock exchanges around the world). The “AGG” or total bond fund similar to the F Fund charges total expenses of 0.08%.
In total, BlackRock is introducing ten low-cost funds as part of its “iShares” offerings in the coming weeks. (Note: I do not receive any compensation for any discussion of these or any other funds that appear on this site.)
BlackRock’s announced cuts in index fund expenses follow similar cuts to expenses in index funds at Fidelity and Vanguard. Fidelity and Vanguard offer S&P 500 funds similar to the C Fund with expense ratios of 0.06% and 0.05% respectively, for example.
Granted, these still aren’t quite as low as those featured among funds in the TSP, but they are pretty darn close. And these fund companies have a wider lineup of funds than those available in the TSP, with very reasonable expenses as well. While you can’t invest in emerging markets or in any funds that include Canada in the TSP, for example, you can invest in them through any of the fund companies listed above.
Thus, the expenses are low enough that for those leaving the military or government service, it could be worth considering transferring funds out of the TSP and into these other companies. They offer a wider range of low-cost options that can’t be found in the TSP, so interested investors could further diversify their investments while still enjoying incredibly low expenses.
The expenses are also low enough so that when the TSP finally implements a “mutual fund window,” TSP investors can think of diverting some or all of their investments to these low-cost alternatives.
These alternatives are additionally important as reminders for TSP administrators who are seeking higher budgets over the coming years to modernize TSP services. While higher budgets are inevitable to service the expected increase in both participants and funds in the coming five years, TSP investors should also watch for possible increases in expense ratios among the TSP funds that might accompany these increases in budgets.
In the index fund world, the trend in expenses is down. TSP administrators should remain focused on maintaining low TSP expense ratios, even as TSP budgets expand over the coming years.