The strong performances of the Thrift Savings Plan’s C, S and F Funds over the past two years should be making you nervous. I know it makes you feel good when your TSP account’s value is hitting new highs, but that’s an emotional, rather than a rational, response to what has happened.
The value of large U.S. corporations has risen significantly from the economic crisis low in 2009. In fact, even without dividends, the S&P 500 index, on which the C Fund is based, has doubled in value since then and is now nearing the highs it set in 2000 and 2007. Those were the peaks that preceded the bear markets of 2001-03 and 2008-09.
The value of small- and medium-sized U.S. corporations, which is tracked by the S Fund, also has been rising since 2009. But the current value is above that set during the pre-crisis peak in 2007. While the longer-term history for these stocks appears to me to be a little more constructive than that for large-cap stocks, it is still vulnerable to deep correction.
Then there’s the interesting situation in the bonds that underlie the F Fund. Their value has risen along with domestic equity values over the past 2½ years as the markets have recovered from the effects of the panic selling of 2008 and 2009. At that time, investors abandoned both stocks and corporate bonds at the same time, allowing both to recover at the same time. They turned to U.S. Treasury bonds during the depths of the panic and drove their values higher, then sold them off to lower levels the next year. Since bottoming in value, Treasury bonds have also risen in value to new highs.
So, we have U.S. stocks, corporate bonds and Treasury debt – the assets underlying the C, S and F Funds – at or near their historically high values. If your TSP has been diversified and invested in each of these accounts, as I’ve often recommended, then you’ve participated in this significant increase in value. It’s anyone’s guess where prices will go from here, but you can make some decisions concerning your TSP account that will help to capture the gains you’ve recently accrued.
I’m writing this not because I can predict the future but because I have been seeing a large number of my clients’ financial plans showing signs of being overfunded during regular review during the past year. This happens when their investment portfolios have higher values than we expected them to have. Individually, this can happen for a variety of reasons, but when it happens across the board, it is the result of better-than-expected investment performance.
Any time investment performance is better than expected, and particularly when it has happened in a difficult economic environment, you should start to get a little nervous about what could happen next. It’s simple to understand that the higher asset values go, the more vulnerable they become to losing value and the further they have to fall. This is why it’s prudent to take the opportunity to reduce your portfolio’s exposure to the risk of loss whenever you have the opportunity – that is, whenever your portfolio is worth more than you need to safely support your future needs.
Adding to the urgency this time around is the fact that interest rates are near zero, and just about the only place they can go from here is up. When this eventually happens, the F Fund’s value will suffer. The interest will continue to come in, but the loss in the underlying bonds’ market value could easily negate that interest income and lead to falling share prices.
So, what can you do? The safest thing to do is to maintain the appropriate asset allocation model – the one that best suits your needs – but only after increasing your allocation to the G Fund at the expense of the other funds. At a minimum, you should consider replacing as much as half of the F Fund in your allocation with additional G Fund. This will give you increased protection against rising interest rates while reducing the F Fund’s risk to principal.
Written by Mike Miles
For the Federal Times
Publication September 24, 2012