Question about life cycle fund bond allocation

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Kelly
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Question about life cycle fund bond allocation

Post by Kelly »

The TSP L funds have more in bonds than the M* category average. For example, 2040 has 28% bond vs a 13% average. This has made sense to me. Many TSP participants will have pensions so they can take less risk. Vanguard has a paper explaining their target date methodology here https://personal.vanguard.com/pdf/ISGLCIM.pdf They state that those with a DB plan can take more risk since the pension is a bond. Isn't the idea to maintain standard of living taking as less risk as possible since more risk could make you worse off? Any insight to why TSP has a higher bond allocation?

Many thanks

Kelly
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retiredjg
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Re: Question about life cycle fund bond allocation

Post by retiredjg »

Not sure if this is the answer to your question, but...some target funds glide "to" the target date and do not change allocations after that. Some target funds glide past the target date, continuing to get more conservative afterwards.

The other possibility is that the TSP just set theirs up more conservatively. Or did not budge when other funds changed allocations to a more aggressive stance in order to appear "better" than their competitors.
dbr
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Re: Question about life cycle fund bond allocation

Post by dbr »

Kelly wrote: Mon May 17, 2021 11:46 am The TSP L funds have more in bonds than the M* category average. For example, 2040 has 28% bond vs a 13% average. This has made sense to me. Many TSP participants will have pensions so they can take less risk. Vanguard has a paper explaining their target date methodology here https://personal.vanguard.com/pdf/ISGLCIM.pdf They state that those with a DB plan can take more risk since the pension is a bond. Isn't the idea to maintain standard of living taking as less risk as possible since more risk could make you worse off? Any insight to why TSP has a higher bond allocation?

Many thanks

Kelly
The logic in these discussion can become quite confusing. Clearly when two people start off with the same spending goal and one of them has a pension and other does not, the person with the pension needs to accumulate less money and therefore has less need to take risk. A different logic applies if the person with the pension wants a higher spending goal and is willing to take the risk to make that goal knowing that the pension is a floor that protects them from the worst consequences of investment risk. The reason the second investor can take more risk is because the pension is an income floor and not because it is a bond. The person with the pension can also set their spending need at the same as the person without the pension plus the income of the pension. In that case they might well decide to take the same risk as the person without the pension because they are both using their portfolios for exactly the same amount of hoped for income.

In the extreme case all of a person's spending needs are met by the pension and they can do anything they want with their investments. Options include maximum risk to get as wealthy as possible and minimum risk for their wealth to come out as certain as possible. A more logical response to the situation would be to think more about what they want to do with their money. Some people are plagued by a lack of imagination.

I advocate that a framework for working through all of this is the need, ability, and willingness framework. But doing that requires thinking, imagination, and knowing oneself in preference to pension as a bond, age in bonds or similar shortcuts.

I also think the issues become more clear when applied to individual personal situations than when one attempts to formulate general rules for other people. While the glide paths of target funds have some logic I am not sure exactly how to configure a target fund is all that cut and dried. We already strongly acknowledge on this forum that such funds should be picked for asset allocation and not used as investment advice based on retirement date or age. There is also a suspicion that a lot of these funds are more aggressive than they really should be for marketing reasons of advertising better expected returns. The history of moving those asset allocations around looks a little strange.
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Re: Question about life cycle fund bond allocation

Post by Horton »

The TSP L Funds are currently in the process of transitioning to a more aggressive glidepath:

https://www.fedsmith.com/2020/03/25/cha ... s-l-funds/
With the belief that younger investors will benefit from a higher allocation in stock funds, there is an initial equity allocation of 99% until an investor is 35. This will be reduced to an equity allocation of 60% by the time an investor is 58 and further reduced to an allocation of 30% by the time an investor is 63 when an investor is enrolled into the L Income Fund. Transitioning to this new allocation will take place gradually. L2030, L2040 and L2050 allocations will be completed in 2025, 2028 and 2032.
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retiredjg
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Re: Question about life cycle fund bond allocation

Post by retiredjg »

:shock: 99% stock?

Methinks it is just too much....
NiceUnparticularMan
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Re: Question about life cycle fund bond allocation

Post by NiceUnparticularMan »

I note the availability of the G Fund also leads to a somewhat different calculation than when a fund can only make use of marketed instruments.
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grabiner
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Re: Question about life cycle fund bond allocation

Post by grabiner »

Horton wrote: Mon May 17, 2021 1:40 pm The TSP L Funds are currently in the process of transitioning to a more aggressive glidepath:

https://www.fedsmith.com/2020/03/25/cha ... s-l-funds/
With the belief that younger investors will benefit from a higher allocation in stock funds, there is an initial equity allocation of 99% until an investor is 35. This will be reduced to an equity allocation of 60% by the time an investor is 58 and further reduced to an allocation of 30% by the time an investor is 63 when an investor is enrolled into the L Income Fund. Transitioning to this new allocation will take place gradually. L2030, L2040 and L2050 allocations will be completed in 2025, 2028 and 2032.
Mathematically, this is correct, because TSP investors will also have a pension, and thus have more ability to take stock-market risk.

Practically, it is questionable; even if 100% stock (or 99% stock) is mathematically optimal for a young investor, it may not be consistent with the investor's reaction to stock-market declines. It may be interesting to see how many investors move from 99%-stock funds to the G fund at the next market crash.
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Re: Question about life cycle fund bond allocation

Post by Horton »

grabiner wrote: Mon May 17, 2021 9:03 pm Mathematically, this is correct, because TSP investors will also have a pension, and thus have more ability to take stock-market risk.

Practically, it is questionable; even if 100% stock (or 99% stock) is mathematically optimal for a young investor, it may not be consistent with the investor's reaction to stock-market declines. It may be interesting to see how many investors move from 99%-stock funds to the G fund at the next market crash.
I do not disagree, but, IIRC, at least both Vanguard and Fidelity have said that the majority of TDF investors during Q1/Q2 of last year made no changes. Is 99% much different than 90% in terms of drawdown? Was the rebound too quick in 2020 for TDF investors to respond?
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Kelly
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Re: Question about life cycle fund bond allocation

Post by Kelly »

Thanks all, for the insight. I found this memo summarizing their changes which include increasing the equity allocation https://www.frtib.gov/pdf/minutes/2020/ ... r-Att6.pdf

DB plans are mentioned, but it's not clear if the replacement rate goal takes this into account since they mention US military personnel as having brief employment (not enough to accrue a pension).
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Re: Question about life cycle fund bond allocation

Post by vineviz »

Kelly wrote: Tue May 18, 2021 5:42 am Thanks all, for the insight. I found this memo summarizing their changes which include increasing the equity allocation https://www.frtib.gov/pdf/minutes/2020/ ... r-Att6.pdf

DB plans are mentioned, but it's not clear if the replacement rate goal takes this into account since they mention US military personnel as having brief employment (not enough to accrue a pension).
For a number of possible reasons, the average retirement age of federal employees is typically younger than for private sector workers. This can trigger slight differences in the glide paths, in addition to the generally more-conservative-than-average approach used by the TSP.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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