Expanding federal investment options

Enrollees in the federal government's Thrift Savings Plan (TSP) who want to invest in the stock market can do so only through the C Fund, which is based on the Standard & Poor's 500 Index of 500 blue-chip companies.

The S&P 500 is perhaps the most important U.S. stock market index, but it's by no means the only one. However, you wouldn't know that by looking at the TSP, which views the C Fund as the only game in town. And although more investment options may soon be available to TSP enrollees, the government has been inexplicably slow to make those changes.

The S&P 500 is also probably the most misunderstood market benchmark. It accounts for about two-thirds of U.S. stock market value but excludes the remaining third of the of the market represented by small and midsize companies.

Standard & Poor's, which administers the S&P 500, created the index many years ago as a tool for professional investment firms to evaluate companies' performance. But the index has become the measure of performance for investors and has gained broad acceptance as a stock market benchmark.

Despite the universal exposure it receives, the S&P 500 Index is not what many investors think it is. More than 21 times the number of securities in the S&P 500 are publicly traded in the country's major stock markets. Consequently, thousands of stocks - most of which are small-company stocks - are not in the S&P 500 Index.

Since the inception of the TSP, federal employees who wanted to invest in the stock market have had their choice limited to the C Fund, which is a stand-in for the S&P 500. The Thrift Savings Board (TSB) claims that its selection of the S&P 500 is a prudent one because in the 10-year period ending Dec. 31, 1998, the index appreciated annually by 19.19 percent, which was superior to the return of the Wilshire 5000 index for the same period (18.11 percent).

However, such statistical comparisons are dicey, to say the least. For the 10-year period ending May 31, 1999, the S&P 500 had a 425.76 percent return on investment.

But for the same period, the Wilshire Large Company Growth Index returned 526.42 percent. That illustrates how extremely difficult it is to predict which index will perform best over time.

In addition, you can make the numbers come out any way you want by varying the period of comparison. Clearly, in any given period, some indexes will perform better than others will.

Currently, indexes of large-company growth stocks are performing best, which is why the Wilshire Large Company Growth Index has done so well in the 10-year period ending May 31, 1999.

So should your TSP stock market investment choice be limited to the C Fund?

The composition of the S&P 500 Index is very different from what people commonly believe. Many investors assume that the index consists of one share of each of the 500 stocks represented in the index. That is not true. About half of the index's performance comes from the largest 50 stocks, or 10 percent of the index.

The lopsided representation is the result of the S&P 500 being a "capitalization-weighted" index. That means each stock's weight in the index is a function of the number of outstanding shares and the value of each share. That tilts the performance of the index to the firms with the largest market capitalization. If those firms experience a difficult period while other firms do not, the results will be distorted.

I do not necessarily mean to criticize the S&P index, but I do think federal employees who participate in the TSP should not be limited to the C Fund if they want to invest in the stock market. There are alternatives. For example, the Vanguard Fund Group, a major mutual fund company, offers 10 different domestic index funds that investors can purchase.

The TSB requested congressional authorization in 1996 to offer a small-company index fund and an international index fund to TSP participants. The TSP plans to make those funds available next spring, apparently in recognition of the fact that feds should not be limited to investing in the C Fund.

Why weren't the new funds made available sooner? The TSB said it will take that long to update its system and that Congress prescribed the timetable in the legislation.

Anyone who's been in Washington, D.C., for a while knows that agency staff people and congressional committee staff members meet regularly when legislation is drafted. Could federal employees have been given the opportunity to invest their TSP contributions in a more diversified menu of investment options sooner?

You'll have to ask the TSB.

- Bureaucratus is a retired federal employee who contributes regularly to Federal Computer Week.

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