Managing Money

The Thrift Savings Plan (TSP) rolled out the new mutual fund window over the summer, providing TSP participants a choice of nearly 5,000 mutual funds across 300 fund families in addition to the TSP’s core funds. This begs the question, what are mutual funds and how do they differ from the TSP core funds?

Mutual funds and the TSP’s core funds are similar in the sense they are both investment vehicles that pool money from investors to purchase a portfolio of securities, such as stocks, bonds and other securities, depending on the investment strategy of the fund. While there are similarities in the way both types of funds pool investors’ money to purchase securities, there are some notable differences.

For starters, mutual funds are investment companies regulated by the Securities and Exchange Commission (SEC) with the Financial Industry Regulatory Authority (FINRA) regulating the broker-dealers and representatives that sell mutual funds. Mutual funds are available to the public and may be purchased inside retirement plans, such as the TSP (through the mutual fund window) and IRAs, as well as in nonretirement accounts. The TSP’s core funds, on the other hand, are invested in collective trust funds (CTFs), which are only available in tax-exempt plans, such as the TSP, 401(k)s and defined benefit plans. Furthermore, they are regulated by the Comptroller of the Currency rather than the SEC and FINRA.

CTFs have several advantages, including fee transparency, which is typically a single management

fee, unlike the multiple layers of fees associated with many mutual funds. The fees tend to be lower, too, in part because they have fewer regulatory disclosure requirements compared with mutual funds, which can make them less costly to operate.

While CTFs offer several advantages to large retirement plans, such as the TSP, there can be some drawbacks. For example, mutual funds are required to publish a prospectus and report their holdings and performance periodically to the SEC. As a result, key information on mutual funds, such as daily prices, returns, holdings and third-party commentary can be easily found in numerous sources, including newspapers and magazines.

Furthermore, there’s a plethora of screening tools offered by research firms, such as Morningstar, as well as brokerage firms, that investors may use to research and compare mutual fund performance, fees and other pertinent information necessary to make an informed decision. Information on CTFs is more limited, and investors typically must rely on the retirement plan for information.

Another significant difference is how mutual funds and CTFs handle the investment income, such as interest, dividends and capital gains generated by the securities held in the funds. By law, mutual funds are required to distribute, at least annually, the net investment income in the form dividend and capital gains distributions to the fund’s shareholders. While some mutual fund owners take the dividend and capital gains distributions in cash, other investors choose to reinvest those distributions, buying additional shares of the mutual fund.

CTFs have no such distribution requirements and, as a result, do not make dividend or capital gains distributions. This

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has led some TSP participants to mistakenly believe the TSP core funds do not hold dividend-paying stocks or that they’re being short-changed, because they’re not receiving any dividend distributions. Neither assumption is true. Many of the stocks held in the C, S, and I Funds pay dividends, and the bonds in the F Fund pay interest. Rather than distributing this income to shareholders, however, the CTF simply collects this income and factors it into the daily unit price of the funds.

Tracking the dividends, interest and capital gains a fund’s investments generate, processing the distributions to shareholders and then handling the reinvestment of those distributions all comes at a cost. Simply collecting the investment income and factoring it into the unit price helps reduce the CTF costs, which ultimately benefits the CTF investors.

Mutual funds and collective trust funds share many similarities. Now that both are available within the TSP, it will serve TSP participants well to understand the similarities and differences.

MARK A. KEEN, CFP®, PARTNER, KEEN & POCOCK. SECURITIES OFFERED THROUGH THE STRATEGIC FINANCIAL ALLIANCE INC. (SFA), MEMBER FINRA/SIPC. ADVISORY SERVICES OFFERED THROUGH STRATEGIC BLUEPRINT LLC AND SFA. MARK KEEN IS A REGISTERED PRINCIPAL OF SFA AND AN INVESTMENT ADVISER REPRESENTATIVE OF SFA AND STRATEGIC BLUEPRINT LLC. SFA AND STRATEGIC BLUEPRINT ARE AFFILIATED THROUGH COMMON OWNERSHIP BUT OTHERWISE UNAFFILIATED WITH KEEN & POCOCK. NEITHER STRATEGIC BLUEPRINT NOR SFA PROVIDE TAX OR LEGAL ADVICE.

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