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TSP Smart Investor& Vanguard Smart Investor

The Smart Investor Allocation Guide 

Investing Basics

1) Understanding your basic investment options?  


The three broad categories for investing are stocks, bonds and cash-like accounts (money market, GOV TSP G fund).  Stocks represent an ownership in a company with a claim on the company's assets and earnings.  Bonds are in essence a loan to the company at a set interest rate.  This guide does not focus on individual stocks and bonds, but on investing in baskets of these securities via managed funds that track popular stock market indexes and the Barclays Capital Aggregate Bond Index (a broad-based bond index).  When analyzing these funds we focus on the broader measures of the indexes to determine expected future returns and to determine when we need to buy or sell the fund based on market conditions.

Cash-like accounts (money marketare the safe place to park your money which means they cannot lose money and may pay a low interest rate.  In most brokerage accounts, when securities are sold the proceeds are automatically moved into cash accounts and can be automatically be "swept" into FDIC insured money market accounts. For some managed 401K and TSP accounts, investors have to set their allocation levels so that they add up to 100%.  In the case of the TSP account, setting 100% to the TSP G fund would be the equivalent of being 100% in a cash-like account.  

In today's environment, I prefer cash-like accounts and very short duration bonds when not invested in stocks (G fund for GOV TSP accounts).  Getting our stock allocation percentage and timing correct will have a significantly greater impact on your investment returns than the return obtained today on bond yields and attempting to time bond funds.  

While some bonds are referred to as fixed-income, this is misleading.  While the periodic payment of these securities is usually fixed, the price of these investments swings in the opposite direction of the market's ever changing interest rates.  If the current interest rates are declining, then bond prices rise and vice versa.   Bonds and other fixed income securities are issued with a maturity date from 4-week government T-bills to 30-year bonds.  

The price of long term bonds will increase or decrease more than a shorter term bond funds.  In other words, the higher interest rate does not guarantee a higher return since the price of these bonds can decline significantly when interest rates are rising. Fixed income index funds target a certain time horizon such as 5 - 7 years for the TSP F fund and continually adjust their securities held to maintain the targeted duration and so you receive the current yield the market is paying for that time duration.  

The price swings of shorter duration bonds are much lower than the prices of stocks. Speculators can take advantage of the price swings in the bond market, but our opinion is our focus should be on avoiding risk in the stock market while capturing as much of the gains as possible.  Today when out of stocks, we recommend parking our money in low risk funds such as cash-like accounts (money market, GOV TSP G fund) or very short duration government T-bills.    

For those with the Federal Government Thrift Savings Plan (GOV TSP) accounts:  GOV TSP offers 3 equity funds:  C fund  (tracks the S&P 500 index),  S fund (tracks index that invests in the rest-of-the-US stocks or non-SP500 companies), and I fund (an international fund that tracks the MSCI EAFE index).  GOV TSP offers a "fixed-income" fund with a 5 year target duration for interest bearing securities.  The G fund also provides a yield like the F fund (fixed income) and is the only fund that can not lose money.  In our opinion this makes the TSP G fund a no-brainer for investors to park their money when not in the stock market.  In today's environment, speculators can take advantage of the GOV TSP F fund, but only for short duration trades.   

2)  Understanding the basics of equity (stocks) index fund investing?

Large Cap Indexes:  The most popular index funds track the performance of the S&P 500 index.  The total US stock market consists of around 5000 companies.  The S&P 500 includes 500 of the largest companies that are listed on the NYSE and NASDAQ stock exchanges. While the S&P 500 index only contains 10% of the companies listed on the US stock exchanges, these 500 companies account for 80% of the total market value the US stock market.  The market value of a company is the price of its shares times the number of shares outstanding it has issued. 

Small Cap Indexes:   Like other managed retirement accounts, the GOV TSP offers an index that tracks small and mid-sized companies that typically offer greater growth potential when the US economy is strong. The TSP index fund that tracks the rest-of-the-US stock market  is the TSP S fund that I often show the charts for using the Vanguard VXF ETF. This "rest-of-the-US" fund is made up of small and medium sized companies that tracks the Dow Jones Total US Market Completion Index.  This index is unique in that there is no overlap with the S&P 500 index companies, so one can gain exposure to the total US stock market by owning a fund that tracks the S&P 500 index fund and the completion index.  

Some funds only invest in medium sized companies that may overlap with the S&P 500 or small cap funds such as the Russell 2000 small cap index.   Index fund profiles tell you the index they are trying to track and you can study the criteria for that index to know what you are getting.   I will be providing more information on the more common indexes that many funds track soon.  For those who are investing in managed retirement accounts such as TSP, you will have limited options which actually make the process easier.

Advantages of Index funds: The main advantage of investing in a S&P 500 index fund is that it provides diversification in the leading US companies.  Poorly managed companies cannot achieve the size to become a leading company or remain in the index.   If a company falters and declines in value, it will be removed from the index and replaced with a new growing company.  Investing in an index fund is called passive investing since the fund's managers are not "actively" selecting stocks.  The natural selection process has been proven to beat "active" money management especially after considering the higher fees active funds charge.

Admin and Taxes:  Taxes considerations are not an issue when investing in retirement accounts (IRA/401K/TSP) since your money is not taxed until you withdraw it in retirement.  Commissions charged on buying and selling of securities can be at high cost brokerages, but should be low or in the case of TSP they are non-existent.  The funds you invest in will have a small management fee that in managed accounts you will have little control over.  We provide a ETF guide and mutual fund guide that lists low cost funds for self-managed accounts that we provide timing recommendations for.

The index fund managers do most of the work for you by purchasing and holding the shares that make up the index.  You are in effect an indirect partial owner for a broad range of companies.  The index fund collects dividends from all the companies (typically re-investing them) and passes dividends and price appreciation (or losses) onto you in the form of a single price quote for your fund.  

For self-managed brokerage accounts, mutual funds provide you taxable gains and dividends for your tax returns each year.   Electronic Traded Funds (ETF) are index funds that trade like stocks and do not require paying taxes for capital gains until you sell the ETF.  If either type fund is held in a tax deferred account, you do not pay taxes on gains or dividends.   While this eliminates one of the advantages of ETFs, ETFs still offer the advantages of low fees and lack of early withdrawal fees and lack minimum investment requirements.  Some mutual funds lock you in for a certain period of time before allowing you to sell - this is usually not a problem with seasonal investing, but if market conditions are uncertain ETFs offer more flexibility.






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