L Funds: A Love Affair

My wish for you is that someone loves you as much as I love retirement target date funds. Since becoming a qualified default investment alternative for workplace retirement plans in 2006, this type of retirement account investment choice has become pervasive. According to Morningstar Manager Research, investors held a record $3.5 trillion in target date funds at the end of 2023.

And so it goes for federal employees and the Thrift Savings Plan version, the Lifecycle (L) Fund family, which became the default option for TSP participants in 2015. According to the TSP 2022 Annual Report, almost 67% of younger federal employees are enrolled in L Funds and I, for one, am here for it! The reason I am such a big proponent of L funds is that they efficiently automate what most people have neither the expertise nor inclination to do manually. They ensure that your retirement account is not only properly balanced in terms of overall risk tolerance, but also well diversified within asset classes. 

To those who say that target date funds, such as the L Funds, are fine for beginners but that more sophisticated investors should move on, my retort is that no one outgrows the need for asset allocation (stocks versus bonds) and diversification (different types of stocks and bonds). But there is a kernel of truth in the criticism of funds such as L; they propose a “one-size fits most” solution. Some of us are unicorns, or at least we like to think that we are. There is a solution, however.

If you were to take no action, upon enrollment in TSP you would be automatically enrolled in an L Fund that more or less corresponds to the year that you would typically retire, based on your birth year. For someone who joins federal service today at 40 years old, they may be auto-enrolled in the L Fund 2045 which is comprised of 77% equity (the C, S and I funds combined), and the remainder in fixed income, the F and G funds. As they age, the composition of the fund changes, gradually becoming more conservative (more bonds and less stocks) until it arrives at its final destination. You can see this “glidepath” easily on the TSP website. 

Here's the rub: What if you are not the typical 40 year old? What if your risk preference is such that you find the above allocation just a bit too pedestrian for your tastes? The fix is straightforward: Move out along the L Fund continuum and choose the L 2050 or even the L 2055 fund which holds an eye-popping 99% of its assets in stocks. Pop open the hood of the “competing” L Funds and find the one that is a better match for your risk tolerance.

Similarly, many investors are simply uncomfortable with what they perceive as the high level of risk in their “assigned” L Fund. Again, the solution is simple: move backwards along the spectrum until you arrive at a comfortable spot. For our hypothetical 40-year-old new hire above, this might be the L 2035 fund which is only 66% invested in stocks. For me, the criticism of target date funds — that they are not a customizable solution — simply does not hold much water.

And when you do arrive at your final resting place (I mean retirement), when your L Fund transforms itself to the super conservative Income Fund, you still have the option to simply switch it up and go as aggressive as you see fit. This is especially relevant for federal retirees who may depend on their pension for much of the heavy lifting in their retirement, and whose timeline for using much of their TSP wealth is actually not during their own lifetime.

So why not simply construct your own bespoke basket of funds? Because it’s not necessarily that simple. For example, perhaps you have a very clear vision that you want to be about 80% invested in stocks throughout the entirety of your working career. But within that, what is your opinion on U.S. versus international stocks? Big companies versus small ones? What is the ideal balance between these “sub-sectors” that you are targeting? How often will you rebalance your account to maintain that ratio? That requires monitoring performance and — this is the psychologically hard part for many investors — selling overperforming funds and buying underperforming funds to maintain that ratio. 

It’s far easier to choose an L Fund with the overall asset allocation that suits your preference and check in on its glidepath every five years or so. If you look at the typical L Fund glidepath illustration, the progress from “risky” to “conservative” often proceeds at a glacial pace. For example, the L 2050 Fund has an overall equity composition of 82% today…and 79% a decade from now. This is not a fast moving train. 

More generally, if you see your fund has drifted over time far away from your risk preference — perhaps your comfort level with risk and investing has increased over time, even as one would conventionally become more conservative as they near retirement — then feel free to move to a different target year that is in better accordance with your current preference.

Are L Funds a “set it and forget it” solution? For many, they very well could be. The key is that “setting it” requires a bit more work than matching your birth year to the “right” fund. Take a beat to consider what kind of investor you are and whether your designated L Fund matches your investing personality. If not, choose one that does. And then, yes, you can set it, and if you like, forget it.

Financial coach and planner Lisa Whitley retired from the federal government in 2019. Her practice, MoneyByLisa, is a registered investment advisor.