Best TSP Allocation and Strategy

Hello, I'm Michael Bond and welcome to my site.  

I am going to walk you through the TSP funds from a different perspective than you may find anywhere else. 

I've spent years reading a lot of faulty analysis about investing in the TSP funds and the stock and bond markets in general.  Much of it comes from an academic or marketing perspective and not from basic real-world analysis. Nothing I am about to present requires a rocket scientist to understand.  

We are just going over some facts that are rarely discussed.

Part 1

The easy part - eliminate the weakest funds

Chasing past returns is the worst long-term strategy

Do you drive your car by looking in the rear-view mirror?  You should not invest that way either - stop looking at past returns.  

We can do a pretty good job determining the winners going forward based on what's under each fund's hood.  So let's start by eliminating the 2018 weak funds from the mix - the TSP F then TSP I fund.

The TSP F fund will under-perform the TSP G fund while interest rates are rising, period. And since the TSP F fund's yield is usually very close to the TSP G fund's interest rate, it will match the G fund when interest rates are flat. The difference in performance of these two funds are the capital gains or losses the F fund sustains during the year due to interest rate movements.  So unless interest rates are falling, there is no reason to be in the F fund over the G fund.  This explains why the TSP Lifecycle fund for retirees currently holds 74% G fund and only 6% F fund. 

From the F fund’s inception until 2016, interest rates were declining and the F fund's price went up due to the falling rates.  While this makes the F fund's past performance look good when comparing it to the G fund, this has not been the case since 2016 and will not be the case going forward.  The TSP G fund's interest rate is approaching 3% annually.  While the TSP F fund's yield will also climb, for every 1% rise in interest rates the F fund will sustain approximately a 5% capital loss.  So until interest rates stop climbing avoid the F fund.

It is important to understand that you will often see short term bounces in the F fund when the stock market sells off.  Investors are simply running to safety and this causes a very short-term bump in the safer fixed income prices.  This does not occur for the TSP G fund because it does not hold real securities - it is a virtual fund and its interest rate is based on a formula. 

When investors return to the stock market, the bump in the TSP F fund often disappears.  So for long term investors, the trend in interest rates is what matters.  And what is important to understand today is that the trend of declining interest rates bottomed in 2016 and is set to move higher through 2019 or at least until the next financial crisis.   

The G fund will out-perform the F fund while rates are rising and it is still your best safety net in 2018. It is that simple.

Also forget the international fund (TSP I fund)

Note: I define a "long-term investor" as someone who does NOT chase short-term movements in the market.  An investor, not a speculator.

The other fund that long term investors should avoid is TSP’s International fund.  The I fund tracks an international index that invests in the largest 85% of the developed world outside of the US and Canada.  It does compliment the TSP US equity funds from a geographic diversification point-of-view.  But diversification into under-performing sectors is not a benefit. 

The best performing sector in world has been and should remain technology.  And guess where the world’s preeminent tech companies are listed?  They are listed in the US where their returns are captured by the SP500 index which is tracked by the TSP C fund.   

The International index (TSP I fund) is weighted with only 5% tech compared to 27% in the SP500.  It is those top 100 largest Nasdaq listed companies that are tracked in the SP500 index that helped the TSP C fund pull ahead of the TSP I fund.  These are the most profitable growth companies in the developed world and they sit in the TSP C fund.  

The SP500 companies obtain 31% of their revenue outside the US, meaning the SP500 is already diversified internationally.  Better yet the SP500 tech sector obtains 60% of its tech revenue outside the US.  When you add the I fund to your allocations, you are quickly under-weighting the developed world's tech stocks.

The TSP I fund is also holding over a 25% weighting in financial stocks and frankly Europe’s banks and finances are a bug looking for a windshield.  The European Central Banks manipulation of interest rates into negative territory merely covered up the European financial sectors and economic problems and as interest rates rise globally those issues will resurface.

Simply put, I do not see the TSP I fund as a good long-term investment for 2018 and beyond.  While the US stock market may be more over-valued today, the global stock markets were 100% correlated to the downside during the last bear market - meaning you can not hide out in international stocks when the US stock market rolls over.

What about the Lifecycle funds?

The Life cycle funds follow a buy and hold strategy and are simply invested in all five funds to include the two we think should be eliminated from the mix.  The funds are predominately invested in equities until you close in on retirement where they start shifting to the TSP G fund -- 74% in the retirement income producing fund.  The two ovals in the next chart highlight a key point about most Lifecycle funds.  They do lose less during bear (down) markets, but the gain less during bull (up) markets. This means they are less "volatile" and this is marketed as less risky.  With the exception of the Retirement Income Lifecycle fund you run the risk of large losses during bear markets.  You also get the under-performance of the two worst funds during bull markets.  You can do better.

TSP Lifecycle Funds

The Life cycle funds hold proportions of each equity fund (TSP C/S/I) based on their market valueWhile the equity funds are diversified geographically across the developed world based on a value weighted basis, this geographic diversification is under-weight global technology.  We go more indepth on our Life cycle fund page in a link provided at the end of the third page if you are interested in learning more.

So we've now narrowed it down to only 3 funds to consider - the TSP C and S fund and G funds...

...let's take a look at the three best funds that go into the best allocation.

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